What Is the Purpose of an LLC?

By Ari Mushell, J.D.

What Is the Purpose of an LLC?

By Ari Mushell, J.D.

Since the limited liability company (LLC) first emerged in Wyoming in 1976, it has caught fire and is now available in all 50 states. The primary reason an individual or a group of people choose to structure their business as an LLC is that it provides its owners, called members, with the following benefits:

  • Limited liability: LLCs protect the personal assets of their members.
  • Taxation: LLCs provide members with an advantageous tax scheme through pass-through taxation.
  • Formation: LLCs are fairly simple to form in most states.
  • Special allocation: LLCs allow members to structure the company so that distributions are disproportionate to ownership stakes.

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In short, an LLC's purpose is to provide its members with asset protection and favorable taxation while being easy to incorporate and allowing for flexible profit distribution.

Limited Liability

One of the first considerations, when a new business is launched, is protecting the personal assets of the owners from business creditors. In a sole proprietorship, for example, there is no legal distinction between the owner and the business. As a result, a business creditor can satisfy debts owed from the owner's personal assets. In contrast, an LLC provides liability protection such that a business creditor cannot satisfy debts from the personal assets of the owners, called members. This holds for both single- and multiple-member LLCs.

While the name "limited liability" seems to suggest that a member has some measure of personal liability, members are actually shielded entirely so that there is no possibility of personal liability for members when they've incorporated as an LLC.

Pass-Through Taxation

An LLC provides members with pass-through taxation, thereby avoiding double taxation. That is to say, the LLC does not follow the corporate structure where the corporation first pays corporate taxes on its profits, and the owners and employees then pay taxes on the salaries and dividends they've received. LLC profits are not taxed at the corporate level; instead, the profits "pass through" to the members who pay personal income tax on salary and dividend distributions received from the LLC.

Ease of Formation

An LLC is easy to form, which is another reason it's an attractive option. In most states, forming an LLC requires only that the potential member or members file one document, the Articles of Organization, with the state agency that has jurisdiction over business. This, together with paying the prescribed fee, is all that is necessary to enjoy the liability protection and other benefits of an LLC.

Special Allocation

Members of an LLC have the right to "special allocation," which is where members can earn profit from an LLC that is disproportionate to their ownership percentage. When forming an LLC, the members draft an operating agreement that outlines, among other things, distributions of profit or losses to members.

With shares held in a company, shareholders receive distributions from the company proportional to how many shares they hold. LLCs have no such requirement. Instead, LLC members have the freedom to structure the contract as they like. The members can draft an operating agreement, should they choose, that provides one member with disproportionate profit distributions. Say a member owns 25 percent of an LLC but that member is well known and therefore acts as the face of the company. That member can reasonably negotiate a 50 percent share of the distributions on the basis of bringing value to the company above his or her investment in it. Such an arrangement is permitted when forming an LLC.

The LLC was created to provide advantages to business owners. Those advantages include limited liability, pass-through taxation, ease of formation, and special allocation.

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.