An LLC (limited liability company) is a common way to organize a business in the United States because it can combine personal liability and flexible tax treatment. The details of LLC formed under state law depend on the state in which you are operating the business.
From a federal-tax perspective, “LLC” is not a single tax category. The Internal Revenue Service explains that a domestic LLC is generally taxed by default. It can be based on a one member ownership or a partnership.
In this blog post, we’ll teach you about an LLC, how it’s structured, and important items you need to know.
Key takeaways
- You create an LLC under state law by filing your Articles of Organization.
- In most cases, LLC members are not personally on the hook for LLC debts.
- For federal income taxes, an LLC can be treated as a sole proprietoship, a partnership, or a corporation.
- A single-owner LLC is usually taxed as a disregarded entity.
- An LLC with two or more owners typically defaults to partnership taxation.
- If the LLC qualifies, Form 8832 can be used to choose corporate tax treatment.
- An LLC taxed as a partnership files Form 1065 and provides owners with a Schedule K-1.
- An LLC taxed as a corporation files Form 1120, or Form 1120-S, after making an S election.
What is a Limited Liability Company (LLC)?
An LLC is a business setup recognized by U.S. states. You register it with your state, and it creates a legal distinction between you and the business. That boundary helps protect your personal assets if the business runs into debts or gets sued. The owners of an LLC are called members, and you can form one alone or with other people.
Tax treatment is often one of the reasons LLCs are popular. Many LLCs are set up for pass-through taxation, so profits are generally reported by the members instead of being taxed at the company level first. The operating agreement is where members spell out profit splits, voting rules, and who can make decisions or sign contracts. For federal taxes, an LLC usually follows IRS defaults unless the owners file an election for a different tax status. In some states, certain licensed professions may need a PLLC rather than a standard LLC.
How is an LLC structured?
State law provides default rules for voting, profits, and authority. An operating agreement can change many rules within state limits. Your formation filing creates the LLC record and lists basic details. Many states call it Articles of Organization.
LLC control can stay with members or shift to managers. Federal tax treatment follows member count unless you file elections. A single-member LLC defaults to disregarded entity status while multi-member defaults to partnership treatment. Update the operating agreement when ownership or authority changes and record major votes for bank accounts and contracts.
Members and ownership
LLC owners are called members under state law. A member can be a person, and many states allow entity members. Ownership uses membership interests, not corporate shares. Members can set profit splits in the operating agreement.
A single-member LLC has 1 owner who controls decisions. The IRS treats it as a disregarded entity under default rules. Income is reported on the owner’s personal tax return. A corporate tax election can change that classification.
A multi-member LLC has 2 or more members and shared decision rights. The IRS treats it as a partnership under default rules. The LLC files Form 1065 and issues Schedule K-1. Profit splits can differ from ownership percentages when the agreement says so.
Member-managed vs manager-managed
So how can LLCs be managed? In a member-managed LLC, members hold the main decision authority. Members vote on major decisions and manage the business operations. The operating agreement can set voting thresholds for key actions. It can also limit who can sign contracts for the LLC.
In a manager-managed LLC, managers hold daily decision-making authority. Managers can be members or non-members hired for management. Members keep ownership rights and vote on major decisions. The operating agreement defines manager powers and limits of those powers in writing.
State formation forms reflect the management choice in the filing record. It also requests the governing authority names and addresses. That record helps banks and vendors confirm who can sign.
Member-managed common use cases
Member-managed LLCs fit owner-operator businesses with a small team. Owners work in the business each day and keep authority close. This model is great for single owners, family businesses, and small service firms.
It also reduces layers of approval for routine choices. The operating agreement can name which members can sign contracts. Clear signer rules reduce bank and vendor issues.
Manager-managed common use cases
Manager-managed LLCs are great for businesses with passive members or many owners. Members invest money and keep voting rights on major decisions. Managers manage staff, vendors, and daily operations.
This model separates ownership from daily management authority. The operating agreement can set spending limits and approval rules. It can also limit who can bind the LLC in contracts.
Operating agreement essentials
An operating agreement sets the internal rules for the LLC. It defines profits, voting, and who can sign for the business. It also sets rules for adding members and buying out members. Strong terms reduce conflict when ownership changes.
Common operating agreement topics include:
- Member ownership percentages
- Profit and loss splits
- Voting rules and meeting rules
- Manager powers and limits
- Signer authority for contracts
- Member exit and buyout terms