What is an LLC? LLC is the acronym for "limited liability company". An LLC is best described as a hybrid business structure, combining elements of both a corporation and partnership (or sole proprietorship, depending on the number of owners). It shares the limited liability characteristic of a corporation and the management flexibility and pass-thru income taxation characteristics of a partnership. Documentation requirements are less stringent for an LLC than a corporation and thus it is well suited for single owner.
Unlike general partnerships, an LLC, like a corporation, is created by filing a document with an officer designated by state law. For an LLC the document is usually called the Articles of Organization.
Owners of an LLC are called members. Since most states do not restrict ownership, members may include individuals, corporations, other LLCs and foreign entities. There is no maximum number of members and most states permit “single member” LLCs.
Advantages of an LLC:
Limited liability - members are protected from liability for acts and debts of the LLC.
Pass-through taxation - LLC profits are not taxed at the LLC level if the default tax classification is selected. Profits are passed thru to the member and taxed at the member level. This means no double taxation as may occur with a C corporation.
Taxation flexibility: an LLC can elect to be taxed as a sole proprietor, partnership, S-corp or corporation by simply selecting the desired option.
Requires only one person or owner. In some states the owner can be another entity such as a corporation or another LLC. All states allow one member LLCs.
Enduring legal entity which survives the illness or death of the owner(s), unlike a sole proprietorship.
Minimal administrative paperwork and record keeping. Most states do not require an annual meeting, however, it is advisable to check your state's requirements.
Actual power in the LLC is not shared with a separate board of directors although an operating agreement can provide for a centralized management structure such as a board.
Membership interests of LLCs can be assigned, and the economic benefits of those interests can be separated and assigned.
Disadvantages of an LLC:
Member earnings are generally subject to self-employment tax.
The LLC may not be permitted to elect partnership classification for federal tax purposes if it has only one member.
If more than 35% of losses can be allocated to non-managers, the limited liability company may lose its ability to use the cash method of accounting.
No incentive stock options or tax-free reorganization for LLCs treated as partnerships.
Some states do not tax partnerships but do tax limited liability companies.
Minority discounts for estate planning purposes may be lower in a limited liability company than a corporation.
The rules by which an LLC is governed are contained in LLC's operating agreement. An operating agreement is an agreement among limited liability company members governing the LLC's business, and member's financial and managerial rights and duties. The operating agreement of an LLC is similar in function to the bylaws of a corporation.
To form an LLC, complete the articles of organization (or certificate of organization, depending on the state) and file with the appropriate state office. The legal existence of the LLC begins with the filing of these organizational business forms. Prior to starting business operations, the members should complete an LLC Operating Agreement that sets forth the rules for running the LLC and the rights of the members.