Limited Liability Basics
A limited liability company is a state-based business structure. LLCs provide owners, called members, with limited personal liability for the debts and actions of the LLC. So, if the LLC has incurred debt or faces a lawsuit, only the assets of the LLC itself are at risk, not the members’ individual assets (unless an LLC member has engaged in illegal, reckless or unethical behavior). This liability protection is the typical reason a business entity forms a new LLC, whether for a particular project, a series of related projects or for any business ventures or purposes. When a business entity becomes a member of a new LLC, the business entity member is not liable for the debts of that new LLC. Only the assets of the new LLC are at risk.
Ownership and Operations
When an LLC is owned by one or more business entities, it is typically governed by the owners of the business entities. How this governance works is up to all of the LLC members. Ownership interest does not have to correspond with financial contribution or with how much work each owner does. You should set out member rights and responsibilities through an operating agreement. A typical operating agreement includes percentage interests in the business, voting power and requirements, division of liabilities and assets, management directives, meeting rules, dissolution procedures and buyout provisions.
Just as with individual members, business entity members of an LLC can either be active or passive. Members that actively and continuously manage the company are called “member managers.” Passive members generally do not take part in management and usually limit their involvement to monetary investment. The IRS taxes the profits of passive and member managers differently. Check with the IRS to determine the tax consequences for your LLC ownership and management.
States do impose a few restrictions on LLCs. Some types of businesses simply cannot be LLCs, including banks and insurance companies. In addition, some states have what are called “professional LLCs” in which all members, including owners of the business entity member, may need to hold a professional license related to the LLC’s specific business. There are also restrictions for foreign LLCs. For instance, a group of business entities wants to form an LLC in the state where the venture or project will be located, but none of the entities are from the state. You may want to seek the assistance of a lawyer to better understand the business and tax implications of forming a foreign versus a domestic LLC.