What is an LLC? The plain-English guide.

How the liability protection works

The name says it: liability is limited. If the business owes money or loses a lawsuit, creditors can generally go after what the LLC owns, not your home, car, or personal savings.

The protection has edges, and it helps to know them before you rely on it:

• Personal guarantees. If you sign a lease or loan personally, you are on the hook for it.
• Your own actions. You stay responsible for your own negligence or wrongdoing, even while working for the LLC.
• Mixing money. Courts can set the protection aside, often called piercing the veil, when owners treat the business account like a personal one or ignore the line between the two.

How an LLC is taxed

The IRS does not have a separate tax category for LLCs. Instead it treats them by default based on how many members they have. A single-member LLC is a disregarded entity, so its profit lands on the owner's personal return. A multi-member LLC is taxed as a partnership: it files an information return and each member reports their share.

This is called pass-through taxation, because the profit passes through the business to the owners. An LLC can also elect to be taxed as an S corporation or a C corporation when the numbers support it. The LLC taxes guide walks through each option.

Benefits

The reasons most first-time owners choose an LLC:

• Personal assets kept apart from business debts.
• Simple setup: one state filing, and far fewer formalities than a corporation.
• Flexible taxes, with the option to elect corporate treatment later.
• Flexible ownership: profits can be split in ways other than ownership percentage when the operating agreement says so.
• Credibility with banks, vendors, and clients, plus your business name on record in your state.
• A clean base for business credit, since the LLC can hold its own accounts and EIN.

Drawbacks to weigh

An LLC is not free to keep, and it is not the right fit for every plan:

• State fees to form it, plus annual or biennial reports and, in some states, franchise or privilege taxes.
• Self-employment tax on the profit under default tax treatment.
• Investor fit. Venture investors usually want a C corporation, which can issue different classes of stock.
• Rules differ by state, and doing business in another state can mean registering there too.

LLC, sole proprietorship, or corporation

A sole proprietorship is what you have by default when you work for yourself without filing anything. It costs nothing to start, but there is no line between you and the business: its debts are your debts.

A corporation is the more formal option. It has shareholders, a board, required meetings and minutes, and by default pays its own income tax. An LLC sits between the two, with the protection of a corporation and much of the simplicity of a sole proprietorship.

If a corporation fits your plans better, see C-corporation formation.

When forming one makes sense

There is no single right moment, but these are common signals it is time:

• You are signing contracts, a lease, or client agreements.
• You are about to hire, or bring in a partner.
• You have personal assets you want kept apart from business risk.
• You need a business bank account, payment processing, or business credit.
• You want your business name on record before you invest in a brand.