An LLC, or limited liability company, is a business structure that protects your personal assets from the company’s debts and lawsuits while letting the business’s profits be taxed once on the owners’ personal tax returns rather than at both the business and individual level. It combines the liability shield of a corporation with the tax simplicity of a partnership or sole proprietorship, and that mix is why the LLC has become the most popular entity type for new small businesses in the United States. Most states let one person form one, and the paperwork is lighter than what a corporation requires.
The practical appeal is straightforward. If the business takes on debt it can’t repay or gets sued, creditors can generally reach only what the LLC owns, not your house, your personal bank account, or your car. And when the business makes money, you don’t pay corporate tax on top of personal tax the way shareholders of a C-corporation do.
Who Owns and Runs an LLC
LLC owners are called members. A member’s interest represents both a share of profits and voting power, but the two don’t have to line up. Unlike a corporation, where ownership is divided into shares of stock, an LLC can split economic rights however the members agree in writing.
Every LLC runs under one of two management models. In a member-managed LLC, every owner has a direct say in daily operations and the authority to sign contracts or hire employees. This is the default in most states and fits businesses where all the owners are actively involved. In a manager-managed LLC, the members appoint one or more managers, who may be members themselves or outside professionals, to run the company. That setup fits better when some owners are passive investors who put up capital but don’t want to handle operations.
The choice affects who can bind the company. In a member-managed LLC, any member can sign a contract with a third party on the company’s behalf. In a manager-managed structure, only the designated managers have that authority. Getting this wrong creates situations where someone commits the company to a deal the other owners never approved, so the decision deserves real thought at formation.
Alongside the management choice, the members should put an operating agreement in writing. It’s the LLC’s internal rulebook: how profits are split, how decisions get made, what happens when someone wants out. A few states don’t technically require one, but skipping it is a common mistake. Without a written agreement, your state’s default LLC statute fills in the blanks, and the defaults rarely match what the owners actually intended. In many states the default splits profits equally among all members regardless of how much capital each one contributed, so a member who put up 90% of the startup money can end up splitting profits 50/50 with someone who put up 10%.
The Personal Liability Shield
The main draw of an LLC is the separation it creates between the business and its owners. If the company borrows money it can’t repay, loses a lawsuit, or faces a judgment, creditors can go after the LLC’s assets but generally can’t reach the members’ personal property. Each member’s financial exposure is limited to what they invested in the business. Sole proprietorships and general partnerships don’t offer this; the owner and the business are legally the same person.
How Owners Lose the Protection
The shield isn’t automatic once you file the paperwork. Courts will “pierce the veil” and hold members personally liable when the LLC wasn’t treated as a genuinely separate entity. Judges look at the overall picture, but a few behaviors reliably invite scrutiny:
- Commingling funds: using the LLC’s bank account to pay personal rent, car payments, or credit card bills, or depositing business revenue into a personal account.
- Undercapitalization: starting the LLC without enough money to cover its foreseeable obligations, so the company was never realistically funded to operate.
- Ignoring formalities: no operating agreement, missed state filings, no documentation of significant business decisions.
- Alter ego behavior: running the LLC as an extension of your personal life with no meaningful separation between the two.
- Fraud: using the LLC to misrepresent financial conditions or take on obligations you never intended to pay.
The common thread is that the LLC has to actually behave like a separate entity. Owners who keep a dedicated business bank account, sign contracts in the LLC’s name, document major decisions in writing, and avoid treating the business account like a personal wallet rarely face veil-piercing claims. The owners who get burned are almost always the ones who treated the LLC as a formality on paper while ignoring the separation in practice.
How LLCs Are Taxed
By default, the IRS does not treat an LLC as a separate taxable entity. A single-member LLC is a “disregarded entity,” meaning the owner reports all business income and expenses on Schedule C of their personal return, the same way a sole proprietor would.1Internal Revenue Service. Single Member Limited Liability Companies A multi-member LLC is taxed as a partnership by default: the LLC files an informational return (Form 1065), and each member receives a Schedule K-1 showing their share of income, deductions, and credits, which they report on their personal returns.2Internal Revenue Service. Limited Liability Company (LLC)
Either way, the business itself doesn’t pay federal income tax. Profits are taxed once, on the members’ individual returns. That avoids the “double taxation” C-corporations face, where the company pays corporate income tax on its earnings and shareholders pay a second tax on dividends.
The Self-Employment Tax Catch
The tradeoff for pass-through simplicity is self-employment tax. Active LLC members owe Social Security and Medicare taxes on their share of business profits at a combined rate of 15.3%, covering both the employer and employee portions that would normally be split between a company and its workers. Of that total, 12.4% goes to Social Security on earnings up to $184,500 in 2026, and 2.9% goes to Medicare on all earnings with no cap.3Internal Revenue Service. Self-Employment Tax (Social Security and Medicare Taxes)4Social Security Administration. Contribution and Benefit Base Higher earners also face an additional 0.9% Medicare surtax on self-employment income above $200,000 for single filers or $250,000 for married couples filing jointly. Self-employed individuals can deduct the employer-equivalent half of the self-employment tax when calculating adjusted gross income, which softens the hit.
Electing a Different Tax Classification
LLCs aren’t locked into default pass-through treatment. An LLC can elect to be taxed as an S-corporation by filing Form 2553 with the IRS. Under S-corp taxation, the owner pays themselves a reasonable salary (subject to payroll taxes), and any remaining profit passes through as a distribution not subject to self-employment tax. For a profitable LLC where the owner’s income significantly exceeds a reasonable salary, the savings on that 15.3% tax can be meaningful.5Internal Revenue Service. Instructions for Form 2553
An LLC can also elect C-corporation status by filing Form 8832. That makes the entity a separate taxpayer that pays corporate income tax on its earnings, which usually makes sense only for businesses planning to reinvest most profits rather than distribute them.6Internal Revenue Service. About Form 8832, Entity Classification Election Both elections can be changed, but waiting periods and tax consequences apply, so it’s a conversation to have with a tax professional before filing.
How You Actually Form One
Creating an LLC starts with filing a document typically called the articles of organization (some states call it a certificate of formation or certificate of organization) with the state’s Secretary of State or equivalent office. The form is short, but a few fields trip people up.
The LLC’s name must include a designator telling the public what kind of entity it is. Acceptable variations differ slightly by state but generally include “LLC,” “L.L.C.,” or “Limited Liability Company.” The name also has to be distinguishable from entities already registered in the state. Most Secretary of State websites offer a free name availability search; check before you file.
Every LLC must designate a registered agent, a person or service authorized to accept legal documents and government notices on the company’s behalf. The registered agent needs a physical street address in the state of formation. P.O. boxes and virtual offices don’t qualify, because the agent has to be present during normal business hours to accept service of process. If a lawsuit is filed against your LLC and the process server can’t reach your registered agent, a court may enter a default judgment against you without your knowledge.
Once the state approves the articles, the next step is obtaining an Employer Identification Number (EIN) from the IRS. The EIN is essentially a Social Security number for the business, and most banks require one before opening a business account. The IRS issues EINs at no cost through its online application tool, which assigns the number immediately. Avoid third-party sites that charge fees for it.7Internal Revenue Service. Get an Employer Identification Number
Then open a dedicated business bank account. This isn’t just a convenience; it’s one of the most important things you can do to protect the liability shield. A clean paper trail showing the LLC operates as its own entity is exactly what courts look for when deciding whether to hold owners personally liable.
What It Costs
State filing fees for the articles of organization vary widely, generally from around $35 to over $500 depending on the state. Some states charge extra for expedited processing. A handful also require newly formed LLCs to publish a notice in a local newspaper, which can add anywhere from $50 to over $2,000 depending on the county.
Beyond the initial filing, most states charge a recurring fee to keep the LLC active. Annual or biennial report fees range from nothing in a few states to several hundred dollars in others, and some states add a minimum franchise tax on top. Missing those fees or reports triggers late penalties, loss of good standing, and eventually administrative dissolution of the LLC, which costs more to fix than it would have cost to stay current.
Keeping It in Good Standing
Forming the LLC is the easy part. Most states require a short annual or biennial report confirming the company’s address, registered agent, and members or managers. Miss the deadline and late fees accrue; miss them long enough and the state administratively dissolves the LLC. A dissolved LLC loses its authority to conduct business in that state, contracts entered during dissolution may be unenforceable, and the liability protection the members relied on becomes questionable.
One boundary worth knowing: an LLC formed in one state is domestic only in that state. If it starts doing business in another state (an office, employees, regular transactions with customers there), it typically needs to register as a “foreign LLC” in that state. Skip that step and the LLC may be barred from filing lawsuits in that state’s courts, meaning it can’t enforce contracts or recover damages. The state may also assess back taxes, fines, and penalties for the period the LLC operated without registering.