What Is a Limited Liability Company?

Definition & Examples of a Limited Liability Company

Business owners discuss the process of forming a limited liability company
•••

Luis Alvarez / Getty Images

A limited liability company is a type of business structure that someone can choose when they're starting a business. This type of structure protects most of an owner's personal assets, and the business's income is passed through to owners' personal income.

Here's what you need to know about this type of business if you're considering forming a limited liability company.  

What Is a Limited Liability Company? 

A limited liability company is one option a business has when it is choosing its legal structure, alongside other options like S corporations and sole proprietorships. The characteristics of the limited liability company include limited liability for the owners' assets—their liability is limited to their investment in the business. Income from a limited liability company passes through to owners.

  • Acronym: LLC

An LLC is sometimes incorrectly referred to as a "limited liability corporation." Although an LLC can elect to be taxed as a corporation, an LLC is not formed as a corporation.

How Does a Limited Liability Company Work?

Choosing a business structure is one of the first steps business owners will take as they start a new business. You must choose your business structure and then register that legal structure with your state. You'll need to do this around the same time you would apply for a tax ID number and any relevant licenses and permits.

An LLC is formed in the state in which it operates, by filing Articles of Organization with the state in which you will be doing business. A few states use a Certificate of Organization to form an LLC.

Although most states make it relatively easy to file LLC documents online, it's always best to have the help of an attorney to form an LLC. A good attorney will be fully aware of any special state laws that could apply to your situation.

If your LLC does business in several states, you will need to set up a separate LLC registration in each state. The first LLC registration (or "main" LLC) is called a domestic LLC, while the other state registrations are called foreign LLCs.

Along with the required state formation application, an LLC also should have an operating agreement, which defines the purpose of the LLC, how its members work together, and many other details that describe what happens in certain circumstances.

Ownership

The owners of an LLC are called "members" rather than partners or shareholders. The members draw up an operating agreement, and this guides the way they operate the LLC, similar to a partnership agreement in different types of businesses.

An LLC can be owned by individuals, corporations, s corporations, other LLCs, trusts, and pension plans.

Generally, LLCs are most favorable for medium-risk or high-risk businesses owned by people with significant personal assets. LLCs allow these owners to take risks on the business without risking their personal assets. They also benefit from lower taxes than they would experience with a corporation.

Management

An LLC can be managed by a member or by a professional manager. If one of the members is the manager, that person may receive payment as an employee.

Taxation

An LLC is not directly taxed by the Internal Revenue Service. Instead, LLCs are taxed as either a sole proprietorship or a partnership, based on the number of members. in either case, it is the individual owners who are taxed, not the LLC—the income passes through to the owner's personal income tax return.

Types of Limited Liability Companies

There are a few different kinds of LLCs. Depending on your situation, it may be helpful to understand these differences.

Basic LLC

The most basic type of LLC is the one that has been described thus far. It limits personal liability, and it can be created for many types of endeavors. However, some types of business endeavors cannot be LLCs. These include banks and insurance companies.

Professional LLC

A Professional LLC (PLLC) is an LLC set up and owned by specific types of professionals. Typically, medical professionals, accountants, engineers, and architects can form a PLLC. The list of professionals eligible for this type of LLC varies by state.

Series LLC

A Series LLC is a type of LLC that has a main LLC and other separate LLCs within it. They are segregated for liability purposes. Series LLCs are often used for real estate holdings—each LLC in the series can own a different property.

Key Takeaways

  • Limited liability companies (LLCs) are a type of business structure that limits the personal liability of owners.
  • Profits from LLCs are passed through to owners.
  • Some types of businesses are not eligible to be formed as an LLC.

Article Sources

  1. Small Business Administration. "Choose a Business Structure." Accessed Sept. 28, 2020.

  2. Internal Revenue Service. "Limited Liability Company (LLC)." Accessed Sept. 28, 2020.