Choosing a legal structure for your business is one of the most important decisions you will make. There are several types of structures to choose from, and each one is different when it comes to taxes, legal protections, and benefits. Moreover, certain business structures can impact your ability to obtain small business funding. One of the most popular legal structures in the United States is the limited liability company (LLC). There are an estimated 22 million LLCs in our country. A question that many entrepreneurs have is, “What is an LLC?” This Balboa Capital blog article answers that question. It explains what a limited liability company is, how it works, how to apply for one, and more.
The history of the LLC.
The origin of the LLC dates back to March 1977, when the state of Wyoming introduced a business entity called the limited liability company. It was formed by a small team of accountants and lawyers working for an oil company based in Colorado. The goals of the initial LLC were to offer the oil company pass-through taxation and limited liability protections. The widespread understanding and acceptance of the LLC took over a decade, and, during that time, the Internal Revenue Service (IRS) made periodic reviews of the new legal structure.
Fast forward to September 1988, when the IRS issued a long-awaited ruling that businesses registered as LLCs would be taxed as a sole proprietorship or partnership and be afforded the benefits of limited liability protections. The popularity of this business structure increased dramatically when the Delaware LLC Act was passed in October 1993. Today, over two-thirds of all new businesses formed are limited liability companies.
What is an LLC, and how does it work?
This business legal structure provides the limited liability of a corporation and the single taxation benefits of a sole proprietorship or partnership. In addition, if an LLC has one or more partners or shareholders, the business’s profits will be distributed so that everyone agrees. As a result, the LLC can have an unlimited number of owners, and each owner can report business profit and loss on their personal tax returns.
Next, an LLC is a type of business entity that provides some protection against the business owner’s personal liability for company debts. If a devastating event affects an LLC, such as bankruptcy or a lawsuit, the assets (homes, cars, property, etc.) cannot be seized to pay off any judgments awarded by the court. However, these liability protections are removed if the business owner commits any wrongdoing, such as tax fraud or combining business and personal finances.
When it comes to business funding such as loans and credit lines, an LLC owner is not protected if they provide the lender with a personal guarantee or sign the loan contract as themselves and not as the business owner. In addition, if the LLC owner does not repay what they borrow, debt collectors can legally go after their personal assets.
How to form an LLC.
Setting up an LLC is a process that can be confusing for many entrepreneurs. It is essential to know the basics of how it works to get started with your business as soon as possible. Each state may have different rules and regulations for forming a limited liability company. So, you should check with your state to make sure you do everything correctly. Hiring a business attorney or a financial expert to file your paperwork can help save time and ensure that nothing is overlooked. The following steps are necessary to set up an LLC, but others may apply depending on the state in which your business is located.
- Select a name for your company
- File Articles of Organization with the Secretary of State’s office in your state
- Obtain licenses, permits, and zoning clearances as needed from local governments
- Obtain an Employer Identification Number (EIN) from the IRS
- Create operating agreements for members, if necessary
Don’t forget business insurance.
Liability insurance can provide another layer of liability protection for you and your small business. For example, workplace injuries and certain lawsuits can result in big legal fees if you don’t have adequate insurance coverage. However, if you have insurance, there will be funds available to defend and pay a claim. Talk to an insurance agent or broker to determine the best coverage for your business.
LLCs are considered to be a good option for small businesses. They offer liability protection and tax benefits while also giving owners more control over distributing profits. However, LLCs have a limited life in some states, so make sure to do your research. Additionally, if you have an LLC with a partner and leave the company, you may be required to dissolve the LLC and re-form it if you don’t have an agreement outlining the rules for transferring ownership.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.