What is an LLC? Limited Liability Company explained
Published December 18, 2023
Whether you’re just starting a business or looking to change the structure of your established business, you might be considering an LLC. LLC stands for Limited Liability Company, and it’s a popular business designation among small to medium-sized businesses.
This designation limits the personal liability of the business owner. It’s designed to keep the owner’s personal assets separate from business assets so that if they were to file bankruptcy or end up involved in a lawsuit, their personal assets like bank accounts, homes, and cars are protected.
But that’s not the only advantage of an LLC. Let’s get into all the advantages and disadvantages, and compare LLCs to other business structures so you can decide whether an LLC is the right choice for you.
Advantages of an LLC
1. Protection of personal assets
Your personal assets won’t be considered in a bankruptcy or lawsuit.
2. Exclusive rights to your business name in your state
When you register your business name with the state, no one else in that state can use it.
3. Tax flexibility
LLCs can choose to file taxes either as a sole proprietor or as a corporation. Sole proprietors will only be taxed once, whereas filing as a corporation can lead to double taxes for you.
4. Few requirements and less paperwork
LLCs are popular for small and mid-sized businesses because they are easy to maintain and require less paperwork to be filed with your state than a corporation.
5. Few restrictions for owners and management
Corporations are limited to making decisions based on what shareholders or board of directors want. With an LLC, there is no requirement to have a board of directors, therefore the owner(s) can make all business decisions. Since LLC owners have more freedom to run their business, leadership can feel empowered.
6. Profit distribution freedom
LLCs aren’t required to distribute their profits based on ownership percentages or shares. They have the freedom to distribute them as they choose.
Disadvantages of an LLC
1. State restrictions
Your business could be subject to extra fees depending on which state you live in. Visit Mass.gov for everything you need to know about opening an LLC in the state of Massachusetts.
2. Not the lowest cost business designation
LLCs cost more to start and maintain than a sole proprietorship or general partnership.
3. Extra taxes on income
All earned income for an LLC can be subject to self-employment or payroll taxes.
4. Restrictions on members by business type
Certain professions will be required to operate as a PLLC (Professional Limited Liability Company). States have regulations that only licensed professionals in specific trades can be owners of the PLLC. Professions such as doctors, accountants, legal advisors, and architects are some examples. With an LLC, anyone can be an owner.
Sole proprietorship vs. LLC
A sole proprietorship is a business structure meant for one owner, while an LLC can have either one owner or many. (State and Federal Government will refer to LLC owners as “members.”) Sole proprietorship is the simplest business designation and if you are self-employed, this is your designation by default.
An owner of a sole proprietorship must file their business taxes with their personal taxes, whereas an LLC has the option of filing as a sole proprietor or a corporation. This provides the business with the benefit of “pass-through” taxation so they don’t have to deal with double taxation. We’ll talk about the meaning of double taxation later.
A sole proprietorship is cheaper to start than an LLC in terms of fees, but the owner is liable for all company debts and losses. Sole proprietorships are popular for businesses just starting out, but as they grow, owners may want to switch to another business designation for different benefits, like the separation of assets.
Corporation vs. LLC
As we mentioned before, a corporation is a more restrictive business structure than an LLC. Corporations are required to run a certain way whereas LLC owners have freedom to run the business how they want. Corporations must select a board of directors to lead their operations and oversee day-to-day business. They will designate officers to ensure that board and shareholder needs are being met (Chief Executive Officer, Chief Finance Officer, etc.). They are also required to distribute their profits equally or according to percentage of share, whereas LLCs can distribute profits however the owners agree to. There are multiple types of corporations to choose from. The most popular are C Corporations and S Corporations.
C-Corp owners are protected from personal liability. In short, C-Corp owners must file their personal taxes and business taxes separately, which means the corporation is taxed on business profits, and the owner/shareholder is taxed on distributed dividends. That’s where “double taxation” comes from. Due to C-Corps’ restrictive and formal structure, as well as high costs to start, this designation is typically not suited for small, low-risk businesses. That being said, an LLC is allowed to file taxes as a C-Corp if they choose.
S-Corps use pass-though taxation. However, there is still much more paperwork involved and higher startup costs than an LLC, as well as the requirement to have a board of directors. A business can be an LLC and file taxes as an S-Corp since LLC is not a tax designation. It’s also important to note that each state treats S-Corps differently. So if you’re considering starting one, you’ll want to check the laws specific to your state. Find everything you need to know about Massachusetts laws and regulations for corporations at mass.gov.
An LLC can be a good choice for a small business with few owners. Its low-cost startup fees and separation of personal and business assets, while also avoiding double-taxation, are its most attractive features. Remember, if your business grows and changes you can always switch to a different business structure. We’d recommend talking with a legal advisor to help you get started and file your paperwork.