Choosing the right business structure at the outset can ensure that a company is set up in a manner that maximizes benefits to the owners. An LLC is the most common business formation for new companies, and can be structured in several ways with either single or multiple members. The most straightforward and classic way combines the limited liability of a corporation with the pass-through tax advantages of a partnership.
The owners of an LLC are referred to as members. While each state has its own rules regarding these types of business entities, generally an LLC can have either a single member or multiple members. However, forming the company with multiple members is the classic method.
In contrast to a sole proprietorship, which requires only the filing of a single tax return covering both personal and business profits and losses, the Internal Revenue Service requires LLCs to choose how they will be taxed. By default, a domestic LLC with two or more members is classified as a partnership for tax purposes; thus, members are required to file Form 8832 if they wish to be taxed as a corporation. The advantage of being classified as a partnership is that it allows members to benefit from pass-through taxation as opposed to the "double taxation" that comes with the corporation classification. Pass-through taxation means that individual members pay income taxes on their personal tax returns based on their share of the profits and at their individual rates, while the company itself does not pay income tax.
Management of an LLC
State law provides that an LLC can be operated either by the members or by managers designated by the members. By default, the members are in charge of operations, but this can be changed, usually by express language included in the operating agreement. Having members manage the company is the classic form of management and guards against a claim by the IRS that members are merely passive investors. Such a determination by the IRS would prevent passive members from deducting business losses and expenses for tax purposes. Certain state rules may apply to operating structure; for example, some states may require all members to have equal rights in terms of operating decisions. Another local rule may be that if differences arise between members, final decisions must be approved by a majority vote.
Distinguishing a Classic LLC From a Holding Company
Most state laws regarding LLCs assume the company is being run as a business, as opposed to a "holding company" or non-operating entity. The latter type of LLC is generally created for the purpose of owning outstanding shares of another company's stock and considered an alternative to the classic LLC structure.