State law dictates how you can form a limited liability company business entity and the structure it must maintain to retain its LLC status. Most jurisdictions throughout the nation have similar structure requirements. However, for federal tax purposes, the IRS allows an LLC to elect the tax treatment of a corporation.
Limited liability companies are entities separate and distinct from their owners, who are known as members. The business may incur debts, enter into contracts and be a plaintiff or defendant in a lawsuit. The liabilities an LLC incurs remain the sole responsibility of the business entity. If the LLC elects corporate tax treatment, it is also solely responsible for filing an annual tax return and paying the appropriate amount of income tax on business profits. Limited liability companies taxed as a partnership are responsible for preparing an annual partnership return, but have no liability for taxes due on business profits.
The members of an LLC have ownership interests in the business similarly to a shareholder’s interest in a corporation. However, the LLC structure is notably different in that members also have a management interest. This entitles them to actively engage in the management of the LLC or to designate another individual to perform all management functions. This structure provides an LLC member with more control over an investment in the business. If the LLC elects corporate tax treatment, the members' personal tax situations are unaffected by the LLC’s filings and tax payments. However, if the LLC is taxed as a partnership or sole proprietorship, the members are responsible for including their share of business profits on their personal tax returns and paying the appropriate taxes.
Although there is no requirement to make capital contributions to an LLC, members are the sole source of capital infusions into the business other than creditors who provide debt financing. However, if gaining membership to the LLC is made conditional on you providing future contributions, the LLC and its members have a legal claim against your personal assets for any contributions you fail to make.
The structure of the LLC is relatively straightforward; however, altering how the LLC operates may require structural changes within the organization. Most states do not require the existence of an operating agreement, but most LLCs with two or more members will draft one. The operating agreement can alter the members’ rights and responsibilities imposed by state law. A valid operating agreement may include any clause that does not provide for illegal activity. For example, the operating agreement may restrict a member’s ability to manage the day-to-day operations of the business by requiring the LLC to hire outside employees to run the business.