What is a Limited Liability Company (LLC)?

A limited liability company (LLC) establishes a separate entity from the sole proprietor or partners in a business which shields them from some of the liability associated with the business.

An LLC is a business entity that creates a distinction between the business’s assets and liabilities and the assets and liabilities of the owner or partners. Sole proprietors and partnerships who do not file for this distinction leave themselves and all of their personal assets at risk, in the event of a lawsuit or bankruptcy.

The owners are only protected to an extent, however, and the amount of protection is less robust the smaller the company is and the fewer interested parties there are. Still, the personal assets owned before the company’s formation tend to remain protected at least.

Of course, owners of an LLC can still be held accountable by a court in certain cases involving fraud and other infringements. When the court reaches beyond the distinction between the company and the individual, this is known as “piercing the veil.”

A C corporation might provide more robust protection against such risks, but, as we learned before, they experience double-taxation. An LLC avoids double-taxation since the profits go directly through the company to the members, but all of it is subject to income tax and self-employment taxes, which an S corporation designation can help to mitigate.

In fact, an LLC which is already formed can elect to be recognized as an S-corp by the IRS. Then, partners may elect to have some of the profits paid out as income and some paid out as dividends, since the dividends avoid self-employment taxes. An LLC is more flexible than a corporation, such as in terms of how profits can be distributed between owners.

To summarize, an LLC is suitable for smaller businesses that want to avoid double taxation and still need a legal liability shield.

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