Business Formation Types
If small business owners are deciding whether they need an LLC, they can consider factors like liability protection, tax benefits, and their specific business goals.
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Last Updated: March 24, 2026
An LLC is a legal form of business that combines the liability protection of a corporation with the ease of operation of a sole proprietorship. Thus, it helps protect a business owner’s personal assets against losses from business liabilities and debts, without the extra paperwork, expense, and double taxation that can be associated with operating as a corporation.
The primary reason for a small business owner to create an LLC is that it sets up the business as a separate legal entity. In other words, the entrepreneur creates a legal distinction between themselves and their business.
With an LLC, if there’s a lawsuit against the business, it’ll generally be brought against the LLC, not the owner. That helps prevent the business owner from losing their savings, home, or other personal assets if there’s a settlement against the business.
By contrast, as a sole proprietor, the entrepreneur and their business are one and the same. A lawsuit against the business — even if the business is using a DBA name — will be a lawsuit brought against the owner. Some entrepreneurs could stand to lose everything they own.
If there’s a possibility — even a remote possibility — that a product a business sells, a service it performs, or some other aspect of the business could result in any type of harm or loss to others, the owner should consider forming an LLC.
Whether an entrepreneur is launching a new business or they’ve been operating as a sole proprietorship, there are many advantages to forming an LLC. An LLC can give these advantages to full-time ventures and side hustles alike.
As discussed above, the limitation on personal liability is one of the chief advantages of an LLC. Because it’s a separate legal entity from its members, an LLC’s liabilities and debts are the responsibility of the LLC. Thus, the LLC helps shield the owner’s personal assets from loss.
The liability protection can be lost, however, if members personally guarantee financial obligations, are negligent, commit fraud, or intentionally inflict injury or damage.
Owners of LLCs are called members. An LLC can have any number of members. There’s no cap on the number of members an LLC can have, and it’s possible for a solo operator to be the sole member of an LLC. So, an individual can form an LLC even if they plan on being the company’s only owner perpetually. In fact, many one-person businesses choose to operate as an LLC instead of a sole proprietorship. (A sole proprietor is someone who owns a business alone and hasn’t chosen to form an LLC, corporation, or another kind of business entity.)
LLCs have to conform to state and federal regulations regarding ownership, but most LLCs have few restrictions on ownership. Members may be individuals, partnerships, or corporations, and there’s no restriction on what country the members reside in.
Professional LLCs (PLLCs) are an exception, however. Membership and other rules governing PLLCs vary by state, and not all states allow them.
By contrast, a sole proprietorship is limited to only one owner. Sole proprietors have to form a partnership, LLC, corporation, or another entity if they want to bring additional owners into the business.
S corporations limit the total number of shareholders to 100 and don’t allow shareholders who are partnerships, corporations, or non-resident aliens. That said, an LLC can choose to elect this tax status if it will be advantageous for them.
LLCs have a lot of flexibility in how they’re managed. A multi-member LLC doesn’t have a board of directors and can choose how it wants to be managed. It can choose to be managed by all the members, some of the members, or even by an outsider. It can also choose how profits will be divided among members. Members can either actively participate in the business or be passive members of the business. Read more on the multi-member LLC definition.
If a member withdraws from a multi-member LLC, in most cases, the LLC can continue without having to dissolve (close down).
Once members choose how they want to manage the LLC, the details are documented in the LLC’s operating agreement. See the “How to Create an Operating Agreement” guide to learn more about drafting an agreement.
For tax purposes, by default, an LLC is considered a pass-through entity (see the pass-through entity definition). The business doesn’t pay federal taxes on its profits; instead, all the profits pass through as income to the members of the LLC. Each member reports the profits or losses they receive on their individual tax return. They pay the income taxes and self-employment taxes (Social Security and Medicare) due on their portion of the LLC profits. This avoids the double taxation that accompanies a C corporation (the default form of corporation), in which profits are taxed at the business level and again at the individual shareholder level.
Although pass-through taxation is the default way of handling LLC income taxes, there’s an alternative. The LLC can choose to be taxed as an S corporation. In that case, members may be able to reduce the amount they pay into Social Security and Medicare by splitting their earnings between salary and distribution.
Learn more about the tax savings of an S corporation here.
Being able to add “LLC” to the end of a business name gives a company a marketing advantage. It helps the business to be perceived as bigger, more established, and more professional than a sole proprietorship. It helps forestall customer worries that the company might not be up to doing their work or that the business might close up overnight.
An LLC is the legal structure for a business. Business owners can and should use their LLC to conduct all the activities of their business.
Such activities would include:
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If a person is the sole owner of their business, there’s nothing to stop them from operating as a sole proprietorship. For more information, please see: What is a Sole Proprietorship?
In general, an entrepreneur may not need an LLC if they’re just starting out, they’re the only owner and worker involved with the business, and there’s absolutely no chance that what they sell could cause harm or physical or economic injury to anyone.
But if a business owner is concerned about protecting their assets, or the business could be sued for any reason, it’s prudent to consider forming an LLC or even a corporation.
Forming an LLC involves some initial paperwork and ongoing compliance requirements that an entrepreneur wouldn’t have as a sole proprietor.
There are also some fees involved that a sole proprietor doesn’t incur. States charge a fee to form an LLC, for instance, and a few states require a business owner to publish a notice in newspapers announcing their intent to form an LLC. An entrepreneur may incur some other startup and ongoing costs to form an LLC, too.
Although there are costs involved with forming and operating an LLC, those costs are minimal, considering the benefits of the liability protection and peace of mind that come with an LLC.
Sole proprietorships are the easiest and least expensive type of business for a single owner to set up. But in a sole proprietorship, the owner is responsible for paying all business debts and losses. In addition, a business may look smaller and somewhat inconsequential without the “LLC” or “Inc.” designation after the business name.
General partnerships, like sole proprietorships, can initially be easier to start and run than a multi-member LLC or limited liability partnership. However, the big drawback is that each partner is personally responsible for the business actions and debts any other partner creates.
A corporation may be preferable to forming an LLC for some businesses. This is particularly true if the business needs to be recognized as an official entity outside of the United States. It’s also a consideration if the business will be seeking investors, since many investors prefer the corporate structure for the companies they invest in.
Make a better decision about the right form of business by learning more about the differences between business structures.
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Disclaimer: The content on this page is for information purposes only and does not constitute legal, tax, or accounting advice. For specific questions about any of these topics, seek the counsel of a licensed professional.
Not every business needs to be an LLC. The best legal entity for a business depends on its nature, the owner’s risk tolerance, and the future growth plans.
An LLC avoids the double taxation associated with C corporations. An LLC doesn’t pay federal taxes on its profits. Instead, all the profits or losses pass through to the owners and are reported and taxed on their personal tax returns. In a C corporation, profits are taxed twice. The corporation pays taxes on its profits. Then, shareholders are taxed on the money they receive when those profits are distributed to them as dividends.
Another way LLC members can save on taxes is if the LLC chooses to be taxed as an S corporation (please see the What is an S Corp? page for more information). Doing that allows members to split their earnings between salary and dividends. Although dividends are taxable, they aren’t subject to Social Security and Medicare taxes. Thus, members can save on self-employment taxes.
An LLC is a separate legal entity from its owners. The debts of the LLC belong to the LLC, not the LLC members. However, members of an LLC would still be responsible for any debts they have personally guaranteed.
LLCs are popular because they provide the limited liability protection a corporation offers without the extra costs and legal requirements involved with running a corporation.
No, an entrepreneur doesn’t need to have an LLC to sell on eBay. If a person is just selling a few used items, an LLC probably isn’t necessary. But if they sell regularly, having an LLC would be advantageous. Among other reasons, the business would seem more legitimate, plus the LLC would have its own tax ID number or Employer Identification Number (EIN).
No. Just like on eBay, any type of business can offer goods for sale. But if someone plans to do business regularly on Etsy, forming an LLC would make sense.
No, an entrepreneur doesn’t have to have a separate LLC for each business venture they pursue. It’s even possible to operate multiple businesses under one LLC by getting separate “doing business as” (DBA) names (also known as fictitious names or trade names). But for legal or tax reasons, it might be better to form separate LLCs for each business. If someone is considering whether to form separate business entities or run through a single LLC with multiple DBAs, it’s prudent to discuss the matter with a tax advisor or legal counsel.
Entity Comparisons
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When it comes to compliance, costs, and other factors, these are popular states for forming an LLC.
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