What Is the Purpose of an LLC?

By Steve Aycock

The purpose of an LLC is to allow one or more people to operate a business and have liability protection along with certain tax advantages. Another purpose of an LLC is to give business owners an entity that is flexible and easy to maintain, while requiring fewer formalities than other business entities, such as corporations.

Simplified Set-up

The LLC entity is designed to be simple and flexible. Most states require only a single document -- the Articles of Organization -- to be filed when forming an LLC. The LLC structure is based on freedom to contract, which means owners operate an LLC by agreement rather than by-laws or rules designed to protect shareholders of a corporation. In addition, owners forming a new LLC may want to consider drafting an operating agreement. The operating agreement is essentially a contract between members (or owners) of an LLC that sets forth how the LLC will operate and conduct business. In some states, default rules will apply if an LLC does not have a written operating agreement in place. A properly drafted operating agreement can help avoid disputes among members and application of any default state rules.

Liability Protection

One of the main purposes of an LLC is to provide liability protection for the members and managers. Unlike some other business structures, such as a sole proprietorship, an LLC structure protects the personal assets of the owners from business liability. Liability protection is crucial to obtaining equity capital to start or expand a business. Without liability protection, investors would be reluctant to fund business ventures due to the risk of losing more than the investment amount. A properly formed and maintained LLC will normally protect the personal assets of members and managers from a lawsuit or other claim arising from LLC activities.

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Maintenance

LLCs can be easier to maintain than some other business forms. Unlike corporations, which may be required to hold board meetings, keep minutes and observe other formalities, LLCs often have fewer formal requirements. In addition to being convenient and less-burdensome, the simplicity of LLCs translates into less risk for members. By having fewer formal requirements, LLCs also have fewer opportunities for members to slip-up and possibly lose the liability protection of the LLC.

Tax Advantages

Another important purpose of an LLC is to efficiently move income from the business to the members, while avoiding any unnecessary taxes. Unlike C corporations, an LLC is not taxed as an entity. Rather, the income (or loss) generated by the LLC normally flows through to the members and is taxed at the member level as income. Income from a C corporation, on the other hand, may be taxed at the corporate level and then any profits distributed to shareholders may be taxed again as income of the individual shareholders (so-called “double taxation”). By passing income through to its members, an LLC business structure can avoid double taxation issues.

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What Is a Disadvantage of the Corporate Form of Business Entity?
 

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