In the United States, the limited liability company LLC structure is a fairly new concept in business organization. Though still not accepted in all states, it serves as a unique alternative to traditional legal and tax ways of doing business: sole proprietorships, general partnerships, limited partnerships, C (regular) corporations and S corporations.
Given that some states do not allow single-member LLCs, this form cannot be considered as an outright substitute for a sole proprietorship. Nonetheless, the LLC structure is designed to give you the best of both worlds: the limited liability of a corporation while retaining a level of tax simplicity that resembles a partnership.
Features of the LLC Structure
Limited Liability Status.
The main attraction of an LLC is its limited liability status, a feature that it shares with corporations. The LLC limit your personal liability from business debts and damages incurred by the business. It basically lets you off the hook from legal liabilities such as court judgments and legal settlements obtained against the business.
Like sole proprietorships, partnerships, and S corporations, the business profits and losses of an LLC are taxed at individuals’ income tax rates. You will avoid a corporation’s double taxation, where taxes are reported at a separate business level.
Owners of the LLC.
While owners of corporations are called stockholders, LLC owners are referred to as members. A member, who invests in the LLC and receive a percentage ownership interest in return, may be an individual or a separate legal entity such as a partnership or corporation. The percentage ownership is used to divide up the assets of the LLC when it is sold or liquidated, to split up profits and losses of the LLC or to divide up its voting rights. While an LLC can exist with one member, some states such as the District of Columbia and Massachusetts require LLCs to have two or more members.
Flexible Management Structure.
An LLC can be run either by its members or a management group elected by the members. While many small businesses are managed by their own members, an LLC can easily adopt a management-run structure in the following situations: the members decide to employ outside management help; not all of the members want to run the LLC; or an outside investor wants to be given a vote in management.
Flexible Distribution of Profits and Losses.
Similar to partnerships, dividing up profits among the LLC members is not restricted to the members’ capital contributions. You may split up LLC profits and losses any way you wish, as long as it is provided for in the operating agreement.
Starting Your Own LLC
The basic legal documents and procedures involved with starting your own LLC is a simple process. You can prepare the paperwork yourself, or you can hire a lawyer to prepare, sign and file the basic documents to set up an LLC.
The requirements in forming an LLC are as follows:
LLC Articles of Organization
The first formal step to create an LLC is the submission of the LLC Articles of Organization with your state’s LLC filing office. Request a copy from your state’s filing office, typically the Department or Secretary of State’s office, normally located in your state’s capital city (some big states have branch offices). The LLC Articles of Organization is a relatively simple form where you need to supply some basic details about your LLC: name, principal office address, agent and office for receiving legal papers, and names of its initial members or the special management team. Upon submission, the name of your LLC will be checked for possible duplication. Check with the LLC filing office if the additional step of posting a notice of intention to form an LLC in a local newspaper prior to filing your Articles is required (some states require this, while many don’t).
LLC Operating Agreement
The LLC operating agreement defines the basic rights and responsibilities of LLC members. As a matter of prudent business practice, this is crucial documentation that serves as the written guidance for the newly formed LLC. This document usually provides for the purpose of the LLC, its duration, transferability, and management structure. This written agreement also contains provisions on how a new member can be accepted, how an existing member can withdraw, the continuation of the LLC should any member dies or retire, and buy-out rights of existing members. More importantly, the operating agreement defines the percentage of membership interest and the sharing of profits and losses among members.
Given the newness of the LLC business structure, a number of issues, particularly in tax requirements, are still fuzzy. It is best to consult your accountant or tax advisor in the preparation of tax documents for an LLC.
Recommended Books on LLC Structure:
- Limited Liability Companies For Dummies
- LLC vs. S-Corp vs. C-Corp Explained in 100 Pages or Less
- Your Limited Liability Company
- Nolo’s Quick LLC: All You Need to Know About Limited Liability Companies
- LLC or Corporation?: How to Choose the Right Form for Your Business
Article originally published on March 4, 2014. Updated on January 2, 2020.
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