A limited liability company (LLC) is formed under state law. In many situations this is a desirable way to structure a business because of the liability protection provided to its members, the informal rules for governance and tax advantages. An LLC is often described as a hybrid between a corporation, which offers limited liability, and a partnership, which enjoys flexibility and ease of management. Although an LLC is not a recognized business structure under federal tax law, this works to the advantage of the LLC members because it gives them some flexibility in choosing the tax status for the LLC.
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Forming an LLC
Although each state has its own laws and rules for forming an LLC, there are usually three basic legal requirements: an appropriate name, a lawful business activity, and the filing of articles of organization. The name for the LLC must not only be unique, but also include an appropriate designation in the name identifying it as an LLC, such as including the phrase "Limited Liability Company" or using the designation LLC. The lawful business activities of an LLC usually do not include insurance, banking, professional services or nonprofit organizations. If the name and business activity requirements are met, then an LLC is formed by filing articles of organization with the appropriate state agency, usually the secretary of state.
A document often prepared when forming an LLC is an operating agreement, particularly when the LLC is formed by several members. An operating agreement is usually not required by state law. However, an operating agreement is typically prepared in order to identify each member's capital contribution to the LLC, specify each member's rights and responsibilities regarding the management of the LLC, and indicate how profits and losses in the LLC will be distributed among the members. Without an operating agreement, the members’ rights are determined by state law — which may or may not reflect the members' intentions when forming the LLC.
State laws facilitate the management of an LLC by dispensing with the formalities required of a corporation, such as holding shareholder and board meetings, and recording minutes of meetings and resolutions. Failure to properly perform these formalities can result in a corporation's losing its legal status, but for an LLC there is no legal obligation to follow them. In this regard, the LLC is designed to operate with the same informal structure that is found in any partnership.
The information provided by the IRS states that an LLC is not a recognized classification for federal tax purposes and will be taxed either as a corporation, partnership of sole proprietorship. According to the international business lawyers Fukuda Law Firm in California, this is a fundamental benefit for an LLC because the LLC can be structured to be taxed as a partnership under the Internal Revenue Code. This tax classification means that there are no federal taxes paid by the LLC. All of the profits and losses for the LLC flow through to the LLC’s members and must be reported on their individual tax returns. Using this tax advantage provides flexible tax strategies and savings for a business structured as an LLC.