LLC Components

by John Cromwell

When evaluating what type of organizational form to choose for your business, one option for you to consider is a limited liability company. An LLC is composed of a pool of owners, or members, who are registered with a state to participate in a business. Since an LLC operates under state law, how the organization is regulated varies based on where the business is located. Prior to choosing an LLC, it is important to evaluate the major components of the organizational form and consider whether it is right for your business.

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Liability of Members

One of the chief components of an LLC is that it generally limits its members’ personal liabilities for the business’s debts and obligations. As a result, if the business gets sued or lacks the funds to pay off its creditors, the members do not have to pay anything from their personal resources. This protection is not absolute. If the members intentionally kept the LLC’s assets low so it could not pay off its debts, did not keep good financial records, did not observe corporate formalities or used the LLC to defraud others, the members are personally responsible to settle the LLC’s debts.

Member-Managed vs. Manager-Managed

An LLC can be run one of two ways. A member-managed LLC allows all of the members to make decisions regarding the business’s operations and enter into contracts on the LLC’s behalf. A manager-managed LLC restricts the authority to manage the company to a few representatives; the members cannot influence operations unless selected to be a manager. Generally member-managed operations are used for LLCs with a few business-savvy members while manager-managed operations are for LLCs with more members who want to take a “silent partner” role.

Transferability Restrictions

Some states and LLCs limit the ability of a member to transfer his ownership rights to someone else without approval of the rest of the owners. This can make selling your stake or exiting the business very difficult for a member. As a result, LLCs cannot be publicly traded and it can be difficult for an LLC to obtain outside investment.

Tax Status

LLCs are not recognized by the IRS for tax purposes. Instead, an LLC may be taxed as a sole proprietorship, partnership or corporation. Some LLCs, such as banks and insurance companies, are required to be taxed as a corporation. All other businesses can choose how they want to be taxed. By default, all LLCs that have more than one member and are not required to be a corporation are taxed as a partnership. An LLC with one member is taxed as a sole proprietorship by default. If the LLC wants to change from its default to being taxed as a corporation, it must file Form 8832.