What Is a LLC?
By Lora Keleher
, last updated August 4, 2011
An LLC is a type of business structure that is frequently adopted by small business owners. LLCs are a common choice, because they offer the benefits of pass through taxation, like partnerships and sole proprietorships, and the limited liability protection found in S and C corporations. LLCs are incorporated through the state, and each state provides different advantages and disadvantages, which prompts some business owners to establish an LLC in another state. LLC’s provide certain benefits, but they also require that owners follow certain rules and adhere to certain business practices.
One of the benefits of incorporating as an LLC is the liability protection, which shields an owner’s personal funds and assets from business debts, and lawsuits. However, this liability protection is limited, and does not extend to all situations. This is the case for corporations as well, not just LLCs. If an owner personally signs for a loan or secures a debt, fails to withhold and pay taxes for employees, commits fraud, or harms another individual, then they are held personally liable. Additionally, if the owner of an LLC fails to separate personal and business affairs, then they can lose liability protection. An example of failing to separate personal and business matters would be using money from the business account to cover personal expenses, or not having separate bank accounts for each purpose.
The IRS does not classify LLCs as taxable entities. Instead, LLCs must file as a sole proprietorship, partnership, or corporation. Single member owned LLCs are automatically classified as “disregarded entities,” and taxed as sole proprietorships, while LLCs owned by two or more members are automatically classified as partnerships by the IRS. Companies may also file Form 8832, which allows them to be recognized as a corporation for tax purposes. However, by filing as a sole proprietorship or partnership, the LLC gains the advantage of pass through taxation. This means that the business itself isn’t taxed, and instead business profits and losses are reported on the owners’ tax returns. This eliminates the risk of double taxation, where both the corporation and shareholders are taxed on the same funds.
When filing tax returns as a sole proprietorship or partnership, owners of LLCs must report business income separately, typically by filing a Schedule C, and Schedule SE. An LLC classified as a partnership must also file Form 1065, U.S. Return of Partnership Income, which provides relevant information about the business to the IRS. For tax purposes, most LLCs must also apply for an Employment Identification Number, or EIN, and use it when filing tax returns. Additionally, if LLC owners expect to owe more than $1,000 in taxes in a given year, they must make estimated tax payments each quarter, based on a scheduled set forth by the IRS. Individuals who don’t make these quarterly tax payments are subject to penalties from the IRS.
In order to form an LLC, the Articles of Organization must be filed with the Secretary of State or the state agency that oversees businesses. Although the required information varies from state to state, most require the business name and address, the names of members, managers, and agents, and the purpose of the business. Most states provide blank copies of pre-printed forms, so you don’t have to specifically know the requirements. Once the form is filled out, it must be filed with the state, along with the appropriate fee.
Many states also require that the Articles of Incorporation be published in a specified number of acceptable print publications. Once they’ve been published, you send proof to the state, and your business will officially be recognized. Individuals should also prepare, or have an attorney prepare, an operating agreement. This document details how the company will be managed, the obligations of each member, the percentage of profits to which each member is entitled, who is allowed voting rights, and other crucial policies and procedures. By creating this document, you’ll have more control over the structure and operation of your business, as well as increased liability protection.
An LLC can elect to be member managed or manager managed. In a member managed LLC, the owners share management responsibilities equally, unless the operating agreement specifies otherwise. Under this structure, members also have equal voting rights, and the ability to act on behalf of the LLC. In a manager-managed LLC, certain individuals are given the power to vote on business decisions, and to act as representatives for the company. The manger or managers can be owners, or non-owners, and they run the business, while the owners collect profits. Additionally, some LLC’s appoint an agent to whom legal paperwork will be sent. The operating agreement can also further specify management structures and responsibilities.