If you're running a small business, you've probably heard the term limited liability company (LLC) and been the recipient of some confusing but well-intentioned advice about transitioning to an LLC. So let's start with the basics: What is an LLC? What are the advantages? If it's right for you, how do you make the transition?

LLC Explained

According to the Small Business Administration (SBA), an LLC is a hybrid entity that combines the protections offered to S- and C-corporations with the flexibility and tax benefits of partnerships. Think of it as a formalized version of a partnership: All business owners — even if you're the only one — are defined as members. Most states allow multi-member LLCs consisting of individuals, corporations or other LLCs.

Key Benefits

Making the move to an LLC offers several advantages for your business:

  • Pass-Through Taxes: LLCs can have taxes "pass through" the company to members' personal tax returns only. This means they avoid being double-taxed like C-corps, where profits are taxed once on the business side and again on the personal tax return.
  • Protection From Personal Liability: LLCs separate personal and business assets, meaning creditors can't take personal property or savings. LLCs also enjoy liability protection from the acts of employees.
  • Credibility: Another benefit is credibility. Banks, suppliers, partners and potential customers often see the LLC designation as a sign of longevity and stability.
  • Flexibility: Most states don't have residency requirements for LLCs, meaning you can include overseas or non-resident members.

Sole proprietors with no employees won't enjoy the full benefits of an LLC, but are still on the hook for all start-up and annual fees. These costs vary by state; for example, the Wall Street Journal notes that the state of California charges fees based on your total annual income.

Making the Move

If you decide that your business should become an LLC, how do you get started?

1. Pick a name. An LLC's name cannot be the same as any others in the state, and must include the LLC designation. Some words are prohibited, such as "bank" and "insurance" because their nature would require a different business structure.

2. File your articles of organization. This document contains your business name, address and name of all members. In most states you file with the Secretary of State.

3. Draft an operating agreement. Not all states require this, but it's a best practice to create a documented structure for finances and operating procedures.

4. Pay state fees. Check with your Secretary of State, State Corporation Commission, Department of Commerce and Consumer Affairs, Department of Consumer and Regulatory Affairs or the Division of Corporations and Commercial Code for any associated filing fees.

5. Announce your business. States like Arizona and New York require a newspaper announcement of your LLC. Check with your state's business office.

What is an LLC? Simply put, it can be a way to tap into certain liability and credibility benefits but retain the tax advantages and flexibility of a sole proprietorship or partnership. If you think an LLC is right for you, you should speak to a knowledgeable legal and/or tax professional regarding your specific circumstances.

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