How Does a Limited Liability Company Work?

By Jennifer Kiesewetter, J.D.

How Does a Limited Liability Company Work?

By Jennifer Kiesewetter, J.D.

A limited liability company (LLC) is a type of business structure that provides limited liability to its owners without the strict requirements of a corporation. This ease of operation, flexibility, and liability protection make LLCs a popular choice for business formation.

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Forming an LLC

To legally establish an LLC, you file articles of organization with your appropriate state office. These articles must include specific information about your business, such as its name, the registered agent's name, and its effective date.

After filing the articles, many LLCs choose to draft an operating agreement, which outlines how its owners, called members, will manage the company. Not all states require operating agreements, but having an operating agreement generally allows your LLC to run more smoothly by addressing potential issues.

Operating an LLC

The management of an LLC is flexible compared to other types of business formations, such as corporations or limited partnerships. The LLC's operating agreement outlines the company's management decisions, which include how much capital members contribute, what happens if a member leaves, how members approve a new member, and what happens if the LLC members decide to dissolve the LLC.

LLCs can also choose to be member-managed, meaning the members make all management decisions, or manager-managed, meaning the members elect managers to oversee the business's day-to-day operations in their stead. Members may elect both nonmembers and members as managers. The LLC should designate how it will be managed in its articles of organization and operating agreement.

Additionally, members have flexibility when distributing profits and losses. The members of the LLC can consider capital contributions, sweat equity, the type of business, the kind of industry, and any other relevant factors when determining distributions. The LLC should describe these distributions in its operating agreement.

Payment for LLC Members

LLC members are owners of the business, not employees. As an owner, you don't pay yourself a paycheck. You pay yourself a draw from your capital account.

Each member maintains a capital account that reflects their ownership share in the LLC. As a member, you contribute money to your capital account when you contribute to the business. When you pay yourself a draw, you write a check on the LLC business checking account from your capital account to yourself for deposit into your personal checking account.

Make sure you have money in your capital account before you take a draw. Often, when you first launch your LLC, your business expenses may exceed your income, leaving little or nothing left over for your capital account. If you don't have a balance in your capital account, you can't take a draw.

LLC Taxation

As a default, an LLC is taxed as a pass-through entity. The LLC as an entity doesn't pay federal or state taxes, but, instead, the LLC's members report their share of the business's profits and losses on their personal tax returns. Because of this, no taxes are withheld when a member takes a draw to pay personal expenses. Thus, the member must pay quarterly estimated taxes, which depend on the amount of the draw and other factors. You may want to consult your attorney or accountant to determine the appropriate amount.

Members may also elect other types of taxation for an LLC, such as S corporation or C corporation taxation. The Internal Revenue Service taxes S corporations as pass-through entities and C corporations as separate business entities, which means the members report any profits and losses on the LLC's tax returns and not on their personal tax returns. If the LLC is taxed as a corporation, members can pay themselves wages as employees as opposed to taking draws.

When forming your LLC, many questions can arise, and you may find it helpful to consult an attorney or online service provider. Working with an online service provider or hiring a business attorney to assist you in answering your questions could save you time and money in the long run.

This portion of the site is for informational purposes only. The content is not legal advice. The statements and opinions are the expression of author, not LegalZoom, and have not been evaluated by LegalZoom for accuracy, completeness, or changes in the law.