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What is an LLC?

written by: Nicky LaMarco•edited by: Michele McDonough•updated: 8/31/2009

If you are starting a business, you’ve probably heard of a Limited Liability Company (LLC). An LLC provides the company’s owners with limited liability, combining certain aspects of partnerships and corporations.

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    What is an LLC?

    business idea A Limited Liability Company (LLC) is more flexible than a corporation, while still offering some of the advantages and protection that a corporation provides. An LLC is an alternative to forming a corporation or partnership. To form an LLC, the members have to file the articles of organization, and pay the required fees. State authorities then have to accept the articles of organization before the LLC is officially formed.

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    Advantages of an LLC

    Often, one of the main incentives to forming an LLC is to provide asset protection for the members. Because of the LLC, the personal assets of the members and the assets of the LLC are kept separate, protecting the members from being personally liable for any company debts. There are also many taxation advantages to an LLC, allowing members to avoid having to pay separate individual and corporate taxes, and instead only pay taxes on their earnings once, which is referred to as “pass-through taxation." Additionally, an LLC is less formal, and requires significantly less records to be kept, and much less paperwork is needed as compared to a corporation. The members decide among themselves as to the organizational structure of the LLC.

    Another advantage of an LLC is that they can help to avoid problems from occurring upon the death of the owner, or if the owner becomes ill, which can help avoid serious business disruptions.

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    Disadvantages of an LLC

    Although there are many advantages to a Limited Liability Company, there are some disadvantages that need to be kept in mind as well. There may be problems with inconsistency when a business operates in more than one state, due to the fact that LLCs often lack uniformity in statutes. There are also limitations with LLCs when there is a sole member. Although LLCs allow only one member, a federal tax classification of “partnership" is not permitted, unless there are at least two members. Even if a limited liability company is being treated as a partnership, there are limitations, such as being prohibited from engaging in a tax-free reorganization, or being able to take advantage of incentive stock options. Additionally, the LLC being treated as a partnership may be taxed in some states, as opposed to not being taxed as a true partnership.

    There are also some considerations to take into account when converting an existing business to a limited liability company, including the possibility of taxes on appreciated assets. Creating an LLC, as opposed to a sole proprietorship or partnership, is also generally more expensive. An LLC also requires more documentation and paperwork than would a true partnership.

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    The Process of Forming an LLC

    If you decide that an LLC is right for your business, you will need to file the articles of organization with the appropriate agency for your state, and along with the required fees. After being accepted by the state, an organizational meeting will be held by the members of the LLC and an operating agreement will be adopted.