What is an LLC?

What limited liability means

The company's debts belong to the company. If the business can't pay a supplier or loses a lawsuit, the claim is generally against what the business owns. Your house and savings are generally out of reach. California's statute says a company's debt doesn't become a member's debt solely because that person is a member or manager.

The word solely matters. A loan you personally guarantee is still yours, and so is harm you cause yourself. A court can also hold owners liable if the company was really a front for them. Lawyers call this alter ego liability. Keeping business money in a business bank account is the simplest way to show the two are separate. You still want insurance, because an LLC guards your own assets and doesn't pay the claim.

Who can own one

The IRS says most states let members be individuals, corporations, other LLCs or foreign entities. There's no maximum number of members, and most states allow an LLC with a single owner.

A few kinds of business generally can't be LLCs, such as banks and insurance companies. Licensed professionals may face extra rules. California doesn't let an LLC provide the professional services defined in its corporations code, and other states have a professional form of LLC.

How an LLC is taxed

The IRS has no tax category called LLC. An LLC with one owner is ignored for federal income tax by default, so the profit goes on the owner's personal return. An LLC with two or more owners is treated as a partnership by default. It files an information return and gives each owner a Schedule K-1.

Either kind can choose to be taxed as a corporation with Form 8832. An eligible LLC can also elect S corporation status with Form 2553. The SBA says LLC members are considered self-employed, so expect self-employment tax on your share of the profit. An accountant can tell you whether an election is worth it for you.

How it compares

A sole proprietorship takes little or no paperwork, but the SBA describes its owner's personal liability as unlimited. A corporation also limits liability, with shareholders and more formal rules. If you plan to raise money from investors, read about corporations first. Our guide to LLC pros and cons goes through the trade-offs.

What it takes to form and keep one

You file articles of organization with a state and pay its fee. Our state fee list has each one. Most states then expect a regular report, a fee or both to keep the company active. The amounts differ a lot, and a few states, such as Ohio, ask for no annual report. See annual reports by state.

You'll also want an operating agreement and, in most cases, an EIN. The full order of steps is in how to start an LLC.