What is an LLC & How Does It Work

A limited liability company (LLC) is a type of legal designation given to U.S. businesses. LLCs are private, limited companies made up of individual members who have the advantage of personal liability protections, tax benefits and adaptable management options.

Understanding LLCs

LLCs are one of the most preferred business structures because they combine the protections of a corporation with the flexibility of a smaller business. LLC members enjoy limited liability for their personal assets, options when filing taxes and the freedom to manage their business as they choose. There are many types of LLCs, each regulated by their state of registry. They all share a few key characteristics:

LLCs are made up of members, also called owners. There is no limit to the number of owners an LLC can have. You can also form an LLC of just one member — a “single-member LLC.” Membership is flexible: individuals, estates, partnerships and organizations can all join LLCs as owners.
The main benefit of an LLC is that owners take on less risk. Owners carry limited personal liability for any business debts they might incur. This means that their personal assets (like a car, home and bank accounts) are protected should the business owe debts or get into a lawsuit. These kinds of liability protections are unique to LLCs. Sole proprietorships or partnerships don’t extend these kinds of protections to your personal assets.
LLCs are much less formal than corporations. In an LLC, you don’t have to have annual meetings, denote formal officers, or keep meeting minutes and resolutions.
All the profits go straight to the LLC owners. Owners report their earnings share on their individual tax return. Profits are only taxed once, unlike corporations who are taxed twice on their earnings. This is called pass-through taxation.

Example: Let’s say Alex and Marie form a multi-member LLC. As owners, Alex and Marie keep their personal assets — their individual bank accounts, cars and homes — separate from their business assets. Alex reports their earnings on their annual tax return, and Marie reports hers on her own individual tax return. Their LLC owns an office property as an asset, as well as a car.

Takeaway

An LLC gives you the best of both worlds: the personal liability protections of a corporation and the pass-through taxation of a sole proprietorship or partnership.Forming an LLC means you can sleep easy knowing:

Your personal assets are safe if you get sued.
You’ll pay taxes on your own return.
You’re free to manage your business how you’d like.

In more detail

How are LLCs formed?

To form an LLC, you’ll need to file paperwork with the state called Articles of Organization or a Certificate of Formation. This is most often through the Secretary of State. It’s common to follow up this registration process with an operating agreement, delineation of owner contributions and earnings and outlining the management style.

How are LLCs structured and managed?

LLCs can be owned by one person or several people, called “owners.” If an LLC is owned by multiple people, it’s called a multi-member LLC. Alternatively, LLCs owned by a single person are called single-member LLCs. Owners of a multi-member LLC can manage themselves as a group or establish a single manager to govern. These two structures are called “member-managed” and “manager-managed,” respectively.

How are LLCs taxed?

LLCs don’t pay business taxes. Instead, they have a pass-through structure. This means that taxes are sent to the members to report profits on their individual tax returns. Owners are responsible for normal income tax and self-employment taxes.

What are the pros and cons of an LLC?

Pros of LLCs

Pass-through taxation means you’re only taxed once
Personal liability protection (dividing personal and business assets)
Flexibility in how you operate your business
Easy to get started

Cons of LLCs

Start-up costs are higher. An LLC costs more to form and operate than a sole proprietorship or a partnership. You’ll also need to account for annual fees and taxes, which vary from state to state.
Some states make it difficult to remove members if they leave the business.

How are LLCs different from corporations and sole proprietorships?

Corporations are double-taxed, while LLCs are taxed like sole proprietorships. LLCs are also much easier to form and subject to less regulation. Another key difference between the two is that LLCs provide personal asset protection that is unavailable to corporations. Sole proprietorships, by contrast, are completely tied to an individual — as a sole proprietor, you’re personally liable for any debts your business might incur.

What is an LLC in real estate?

An LLC formed for real estate is an entity created to purchase, own and manage property. A single LLC can own one property or several. Just like any other LLC, a real estate LLC affords tax advantages and protections for individuals, guarding members against any personal risk attributed to the property. The property is managed through the LLC’s separate bank account and tax ID. Pacaso offers second home co-ownership via multi-member LLCs. Each property has its own unique LLC that powers all repairs, home decor and maintenance costs associated with ownership. Pacaso homeowners purchase interest shares in a professionally managed LLC specific to one property. LLC co-owners have 100% ownership at closing.

What are the benefits of an LLC in real estate?

Real estate LLCs have been around for years because of the benefits they bring to buyers. Investing in property through a real estate LLC provides the protection of an outside entity — you can buy and sell property with the assurance of avoiding significant personal liability. Here’s an example of how this could play out: Say you’re renting out an investment property and the tenant files a lawsuit because a pipe broke and damaged their furniture. If your LLC owns the rental home, there’s a buffer between your assets and what’s at risk. If you personally own the property, your own assets are up for grabs — including your primary residence. Pacaso provides the safety and ease of co-ownership through a professionally managed LLC, so you get the benefits an LLC provides while skipping the paperwork and risk of managing a property independently. As the manager of your home’s LLC, Pacaso will assume financial responsibility if an owner defaults on payments which means each individual owner is protected. This is one of the benefits of our ownership program.

What is an LLC and how does it work?