What is a limited liability company (LLC)?

August 22, 2023 | 3 minute read

Brad Tyler

Answered by
Brad Tyler
Business Strategy & Intelligence Manager
Bank of America

A limited liability company (LLC) is a business structure that combines elements of a corporation and a partnership. Many small business owners wonder if they should form an LLC for their business to formalize their operations. It’s an important decision that could have an impact on everything from what you owe in taxes to your legal liability. As a result, it is very important to consult with qualified tax and legal advisors when deciding whether and how to form an LLC. Here’s a look at how LLCs work.

 

What are the advantages of an LLC?

An LLC is generally considered one of the easiest ways to structure a business in the U.S., and the paperwork to start one is relatively simple. Beyond this, LLCs have a flexible management structure that allows them to be run by either the members or managers who aren’t members. As an added benefit, many business owners find that setting up an LLC gives a business credibility it did not have as a sole proprietorship.

 

Like a corporation, an LLC generally brings the members personal liability protection from the business’s debts and liabilities — members are generally liable up to their investment in the LLC. And if the LLC elects to be taxed as a partnership, it brings the benefits of flow-through taxation, in which the LLC does not pay taxes on its income at the entity level; instead, the LLC’s income, deductions, gains and losses flow through to the members, who then report those amounts on their individual returns via Schedule K-1. If there are losses, the members can generally use these to offset other income they have earned, subject to certain loss limitation rules.

 

What are the drawbacks to LLCs?

If a member leaves an LLC or dies, the LLC agreement — and in some cases, certain states — may require the remaining members to dissolve an LLC, reestablish it and refile the paperwork. Beyond this, the limited liability protection of an LLC isn’t 100% bulletproof. If the members have not taken other steps to establish the business as a legal entity, like setting up an operating agreement and respecting other corporate formalities, someone could “pierce the corporate veil” in a lawsuit and go after the members’ personal assets.

 

What’s required to set up an LLC?

The members will likely need to obtain an Employer Identification Number (EIN) from the IRS and have a unique business name and a registered agent — either one of the members or a third party such as an attorney or accountant who is authorized to receive legal papers for the members. Depending on the state where the LLC is formed, the members will need to file what is generally known as a certificate of formation or articles of organization. Most states require filing this document with the Secretary of State or a business agency in that state. These forms generally require submission of the following information:

 

  • LLC name
  • The names of the founding members or managers (in some states)
  • The name and address of the registered agent
  • A statement of purpose for the LLC
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