A limited liability company's (LLC) owners are called members, so every LLC has at least one member. These business entities can also have multiple members. Although it's a relatively new business structure, it is attractive for its ease of formation, flexibility, liability protection, and potential tax benefits.
You can create this type of entity by simply by filing articles of organization with the relevant state agency. State law generally governs formation and management, and there are few limits placed on who can be a member. Members might be individuals, other business forms such as corporations or partnerships, trusts, or holding companies. If the business is a professional LLC (PLLC) such as a medical or legal practice, all members must be professionals licensed in that relevant profession.
Like a corporation, the LLC structure shields its members from personal liability for the company's debts and obligations. However, it does not need all the formalities that go along with a corporation, such as officers or a board of directors. This combination of protection and simplicity accounts for its popularity.
Every business should have an operating agreement, which is a contract created by the members that lays down the rules for running the company. For example, the agreement should specify whether the business is going to be member-managed or manager-managed. In a member-managed LLC, the members themselves handle all the day-to-day tasks of running the business. If the business is manager-managed, the company hires an outside individual to manage the business. In some circumstances, certain members handle business operations, and others remain silent partners.
In addition, the operating agreement should address:
- How to distribute assets and liabilities among members
- The share of earnings entitled to each member
- When to make distributions to the members
Even a single-member LLC should have an operating agreement to preserve the legal separation between the member and the company.
The Internal Revenue Service (IRS) treats this type of business structure as a disregarded entity for tax purposes; single-member entities are taxed as sole proprietorships, and multiple-member LLCs are taxed as partnerships. The business itself does not pay taxes on its income. Instead, the earnings pass through to its members, who report their share on their personal income tax returns. This kind of pass-through taxation is an advantage over the double taxation that corporate profits experience, where both the corporation and the shareholders pay taxes on business income. Members must pay self-employment taxes, including Social Security and Medicare tax, and these can be costly for members of a profitable business.
Alternatively, the business can elect to be taxed as a corporation by submitting an Entity Classification Election (Form 8832). When a company makes this election, it pays tax on its earnings, and members then also pay personal income tax on distributions they take as salary and dividends. An LLC that has chosen to be taxed as a corporation can thereafter also elect S corporation status by filing an Election by a Small Business Corporation (Form 2553), provided that its members meet the criteria for S corp. ownership. If this takes place, the business enjoys pass-through taxation, just like a partnership or sole proprietorship, but allows members to designate their earnings in part as salary so that the business pays employment taxes.
If you are ready to form your LLC, keep these items in mind, particularly if you are going to have multiple members running the business. Preparing the required documentation and agreements beforehand will better protect all members should any sudden issues arise in the future.
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