A limited liability company (LLC) separates a company from its owners, protecting the owners from any financial losses, debts or legal liabilities that the business may incur.
What is an LLC?
An LLC is a business structure that combines the simplicity, flexibility and tax advantages of a partnership with the personal liability protection of a corporation. This type of structure “limits” the liability of its owners, called members.
Members can be individuals or other businesses. There is no limit to the number of members an LLC can have, and they can have as few as one member, called a single-member LLC.
LLCs are formed at the state level and aren't recognized as a tax structure by the federal government. An LLC may choose how it wants to be taxed — either as a C-corporation, S corporation, disregarded entity (the default for single-member LLCs) or a partnership (the default for multi-member LLCs). LLC members must apply to be taxed as corporations.
» MORE: LLC vs. corporation
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Pros and cons of an LLC
LLC benefits
Structuring a business as an LLC offers several benefits.
Limited liability. Members’ personal assets — homes, cars, bank accounts, investments — are protected from creditors seeking to collect from the business.
Pass-through federal taxation on profits. Unless it opts otherwise, an LLC is a pass-through entity, meaning its profits go directly to its members without being taxed by the government on the company level. This makes filing taxes easier than if the business was taxed on the corporate level, and if the business loses money, members can shoulder the hit on their own tax returns and lower their tax burdens.
Management flexibility. Managers of an LLC can be either members or outsiders, allowing member-owners to be as involved in the management of their business as they want. In many states, an LLC is member-managed by default unless explicitly stated otherwise in filings with the secretary of state or the equivalent agency.
Easy startup and upkeep. Though it varies by state, the initial paperwork and fees for an LLC are relatively light. Ongoing requirements usually come on an annual basis.
» MORE: Best LLC business loans
LLC disadvantages
Before registering a business as an LLC, consider these possible drawbacks.
Limited liability has limits. A judge can rule that an LLC structure doesn’t protect your personal assets. The action is called “piercing the corporate veil,” and you can be at risk if, for example, you don’t clearly separate business transactions from personal transactions or if you run the business fraudulently in ways that cause losses for others.
Self-employment tax. If an LLC is taxed as a partnership, the government considers members who work for the business to be self-employed. This means those members are personally responsible for paying Social Security and Medicare taxes, which are collectively known as self-employment tax, based on the business’s total net earnings.
Consequences of member turnover. In many states, changes in membership require an LLC to be dissolved and reformed, which requires all the normal legal and financial obligations necessary to terminate and start a business.
» MORE: Best business credit cards for LLCs
Types of LLCs
Single-member LLCs. Entities with one owner who is responsible for the taxes, operations and debt of the LLC.
Multi-member LLCs. Entities with multiple members who share responsibility for the business, all of whom must sign the company’s operating agreement.
Member-managed LLCs. Entities that are managed by the members.
Manager-managed LLCs. Entities whose members hire an outside manager to run daily operations, rather than manage the business themselves.
PLLCs. Entities whose professions are subject to state regulatory board licensing — such as CPAs, legal advisors or medical offices.
» MORE: Member-managed LLCs vs. manager-managed LLCs
How to form an LLC
Choose a name
Register a unique name in the state where you plan to do business. To make sure someone else doesn’t have your business name, do a thorough search of online directories, county clerks’ offices and the secretary of state’s website in your state — and any others in which you plan to do business. For a fee, many states let applicants reserve an LLC name for a set period of time before filing articles of organization.
Choose a registered agent
A registered agent is a person you designate to receive official correspondence for the LLC. Choose a registered agent before filing your articles of organization; states generally require you to list a registered agent’s name and address on the form. Although people within the company usually can serve in this role, states maintain lists of third-party companies that perform registered-agent services.
File articles of organization
This step essentially brings your LLC into existence. States request basic pieces of information about your business, which, if you’ve thought through your business plan and structure, shouldn't be difficult to provide. You’ll also supply details such as a name, principal place of business and management type as part of filing your articles of organization.
Get an employer identification number
The IRS requires any business with employees or that operates as a corporation or partnership to have an EIN, which is a nine-digit number assigned to businesses for tax purposes. The rule applies to LLCs because for federal tax purposes they're either corporations or partnerships.
Draw up an operating agreement
Your LLC operating agreement should include specific information about your management structure, including an ownership breakdown, member voting rights, powers and duties of members and managers, and how profits and losses are distributed. Depending on the state, you can have either a written or oral agreement. Many states don’t require one, but they're useful to have.
Establish a business checking account
It’s generally good housekeeping to keep business and personal affairs separate. Having a separate business checking account draws a bright line between the two. This is critical if you want to mitigate any potential risk to your personal assets if a lawsuit calls into question your business practices.
» MORE: How to pay yourself as an LLC
Get insurance
Forming an LLC can help protect your personal assets from lawsuits. But getting LLC insurance will help protect your business assets, too.
Learn how to start your business
NerdWallet has rounded up some of our best information on starting a business, including structuring and naming your company, creating a solid plan and more.
Frequently asked questions
What does LLC stand for?
LLC stands for limited liability company.
Why choose an LLC?
LLCs are a common type of business structure because they are relatively easy to form and protect owners from being liable for business losses or missteps. LLCs also allow for flexibility in the way they are managed — members can manage the daily operations of an LLC or they can hire an outside manager.
What are the risks of an LLC?
If an LLC’s members engage in certain types of misconduct, a judge may choose to hold them personally liable for the LLC’s actions. In addition to this risk, members may still be required to pay self-employment taxes and any membership changes require the entity to be completely dissolved and reformed.
