What is an LLC?
A limited liability company (LLC) is a business structure that protects the personal assets of owners if the company has debts or liabilities. LLCs combine legal and financial protections of corporations with taxation benefits of sole proprietorships.
Benefits and Disadvantages of LLCs
Key Benefits of LLCs:
- Owners have limited personal liability for company debts and lawsuits
- Profits/losses pass through to owners’ personal tax returns
- Less paperwork than corporations
- Flexible management and ownership
LLC Disadvantages:
- More complex taxes
- Increased paperwork vs sole proprietorships
Formation and Operation
Steps to Form an LLC:
- Choose a business name
- Select a registered agent
- File formation documents
- Create an operating agreement
- Obtain EIN
- Set up licenses and permits
Making Money with an LLC:
- Define business goals and customers
- Formally register the LLC
- Arrange financing and accounting
- Market products and services
- Deliver quality and value
Taxation
The IRS doesn’t tax an LLC directly. Instead, LLC profits/losses pass through to owners’ tax returns. If an LLC has no income, it may not need to file a tax return. However, the IRS may still require a return to verify the LLC operates a for-profit business.
LLCs can elect C corporation status to receive refunds if quarterly estimated payments exceed the tax liability. LLCs set up as S corporations file a Form 1120S but don’t pay any corporate taxes on the income.
The IRS treats one-member LLCs as sole proprietorships for tax purposes. This means that the LLC itself does not pay taxes and does not have to file a return with the IRS. As the sole owner of your LLC, you must report all profits or losses of the LLC on Schedule C and submit it with your 1040 tax return.
Additional Considerations
States charge an initial formation fee for an LLC.
LLCs aren’t required to have income or post profits, but if a business owner is claiming tax deductions through an LLC without reporting income, the IRS is likely to conduct an audit to determine if the LLC is an actual for-profit business.
The IRS will only allow you to claim losses on your business for three out of five tax years. When winding down an LLC, the simplified structure allows for smoothly distributing assets and settling obligations.