Limited Liability Companies: The Basics Rated:

Exploring different options for structuring your small business? There are number of alternatives to choose from, such as sole proprietorships, general partnerships, limited partnerships, C corporations, S corporations and limited liability companies.

While each structure provides different advantages and drawbacks, many small business owners find that limited liability companies (LLCs) suit their needs very well and provide significant tax benefits.

What is a limited liability company?

An LLC has been described as combining the best characteristics of corporations and partnerships. Basically, the business structure offers protection for owners (known as "members" in the LLC world) from personal liability for business debts.

The model for an LLC is similar to a corporation in that it has limited liability, while also providing the pass-through income tax benefits of a partnership. While an LLC may be more complicated to set up than a partnership or sole proprietorship, it is more straightforward to run than a corporation.

State restrictions

When deciding which type of business structure to use, make sure you check on laws with your local LLC filing office, because restrictions on vary by state. For example, in some areas, certain types of businesses - such as insurance firms or banks - cannot form LLCs. Some states also require more than one person to be a member of an LLC, while the majority of states place no limits in this regard - meaning sole proprietors are eligible.

What are the benefits of an LLC?

Limited liability. Both LLCs and corporations have limited liability, meaning the owners are not liable for business debts or claims made on the business. In other words, if your LLC runs into trouble making payments to a creditor, your personal assets are safe.

Tax benefits. One of the disadvantages of corporation is that they are taxed on both the entity and personal level. In contrast, members of LLCs use their accounting software to report income and deductions on their individual tax returns. This is known as pass-through income taxation, in which profits and losses go directly to members.

Simplicity. LLCs do not have the same stringent requirements as corporations, which are obligated to keep minutes, hold annual meetings and make resolutions in order to comply with legal conditions. Essentially, many entrepreneurs find an LLC has less red tape than if they had formed a corporation.

Flexibility. The flexibility of an LLC means members can essentially decide how they want to manage the company and set out the rules in its operating agreement. The company can have an unlimited number of members, which may be comprised of individuals, corporations or other LLCs.

It can also be managed by its members - which is common - or by a group of elected managers. LLCs also have flexibility in the way in which they can use their accounting software to divide profits, losses and assets among members. These terms are also defined in the operating agreement.

How do I form a limited liability company?

Choose a compliant business name. Each state has its own rules for LLC business names. In general, the guidelines state that a new LLC cannot have the same name as an existing one, that the name must end with a designation to indicate it is a limited liability company, and that the name does not contain certain prohibited words. You can contact the LLC office in your state to find out what names are available.

File articles of organization. Next, you file official paperwork known as "articles of organization" (also known as a "certificate of formation" or "certificate of organization") at the state LLC office. These documents are usually straightforward, asking for basic information such as the name and address of the business. You will also be charged a filing fee.

Create an operating agreement. This agreement defines the rights and responsibilities of all members of the LLC. The information included may set out how profits and losses are shared, how the business will be managed, how much interest each member has in the business, guidelines for buying and selling interest, how new members are added, and how members vote.

Publish a notice of intent if required. Some states mandate that LLCs must publish a notice of intent before they can be formed. Basically, this involves publishing a notice in a local newspaper that runs regularly over several weeks. You are also required to obtain an affidavit of publication from the newspaper to file at the LLC office.