What is a limited liability company?

A limited liability company, commonly called an "LLC," is a business structure that combines the pass-through taxation of a partnership or sole proprietorship with the limited liability of a corporation.

Like owners of partnerships or sole proprietorships, LLC owners report business profits or losses on their personal income tax returns; the LLC itself is not a separate taxable entity. Like owners of a corporation, however, all LLC owners are protected from personal liability for business debts and claims -- a feature known as "limited liability." This means that if the business owes money or faces a lawsuit for some other reason, only the assets of the business itself are at risk. Creditors usually can't reach the personal assets of the LLC owners, such as a house or car. (Both LLC owners and corporate shareholders can lose this protection by acting illegally, unethically, or irresponsibly.)

For these reasons, many people say the LLC combines the best features of the partnership and corporate business structures. To learn more about limited liability companies, see LLC Basics.

How many people do I need to form an LLC?

You can form an LLC in any state with just one owner. For more information on forming an LLC, see How to Form an LLC.

Who should form an LLC?

You should consider forming an LLC if you are concerned about personal exposure to lawsuits or debts arising from your business. For example, if you decide to open a store-front business that deals directly with the public, you may worry that your commercial liability insurance won't fully protect your personal assets from potential slip-and-fall lawsuits or claims by your suppliers for unpaid bills. Running your business as an LLC may help you sleep better, because it instantly gives you personal protection against these and other potential claims against your business.

Not all businesses can operate as LLCs, however. Businesses in the banking, trust, and insurance industry, for example, are typically prohibited from forming LLCs. In addition, some states, including California, prohibit professionals such as architects, accountants, doctors, and licensed healthcare workers from forming LLCs.For more information on forming an LLC, see How to Form an LLC.

How do I form an LLC?

In most states, you create an LLC simply by filing "articles of organization" with your state's LLC filing office (which is usually part of the secretary of state's office) and paying a filing fee. A few states refer to this organizational document as a "certificate of organization" or a "certificate of formation." Most states provide a fill-in-the-blank form that takes just a few minutes to prepare. You can obtain the form by mail or download it from your state's website (check your state's secretary of state or corporations division home page).

A few states impose an additional requirement: Prior to filing your articles of organization, you must publish your intention to form an LLC in a local newspaper.

You'll also want to prepare an LLC operating agreement, though it isn't legally required in most states. Your operating agreement explicitly states the rights and responsibilities of the LLC owners. The main reasons to do this are to clarify your business arrangements, and to decide how your LLC will be run. If you don't create a written operating agreement, the LLC laws of your state will govern the inner workings of your LLC.

You can use a self-help book or software program to guide you through the process of creating personalized articles of organization and writing an LLC operating agreement. For more information on forming an LLC, see How to Form an LLC.