Limited Liability Company (LLC)
Limited Liability Companies (LLCs) are, what I like to call, the hybrid of business structures. While LLCs are the newest type of business structure, they have characteristics of both a corporation and a partnership, or sole proprietorship. One of the most unique characteristics of an LLC, as far as federal income taxes are concerned, is that the company can elect how it wants to be taxed, choosing to be taxed as a sole proprietor, partnership, or corporation (as long as it meets the qualifications of the chosen structure), making LLCs the most flexible type of business structure created thus far. For more info on how LLCs are taxed click here.
Even though an LLC is recognized as a legal business entity, it is setup more like a type of voluntary association, in which a group of individuals enter into an agreement to form an organization. The owners of an LLC are normally referred to as the LLC's members. And, similar to a shareholder in a corporation, each member has an ownership interest, or membership interest, in the LLC that is divided up according to that member's contribution to the LLC.
Although there are many similarities between corporations and LLCs, there are many differences as well. LLCs closely resemble corporations in the fact that, like corporations, LLCs offer their owners a high degree of limited personal liability. In addition, LLCs do not restrict owner type or quantity; therefore, sole proprietors that want to limit their personal liability also have the opportunity and advantage of forming a single-member LLC. Basically, this means that the personal assets belonging to the members of an LLC are not normally exposed to legal liability for business debts or judgments placed against the business. Generally, like a corporation, if someone were to become a member of an LLC, their only risk would be their investment into the company.
Taxation of an LLC is a relatively simple concept to grasp. Even though an LLC choose to be taxed as any business structure it chooses, as long as it qualifies, it normally breaks down pretty easy. Single-member LLCs are taxed the same as a sole proprietorship, and multi-member LLCs are taxed in the same manner as partnerships, passing the company's profits, deductions, credits, and losses straight through to their individual taxes. Basically, LLCs, for federal income tax purposes, are not considered to be separate entities from their members, making pass-through taxation available as one of their primary benefits. Multi-member LLCs can, however, choose to be taxed as a corporation in order to take advantage of the tax benefits offered with dual taxation, but most LLCs wont choose that option.
In order to become a Limited Liability Company (LLC), a company must prepare and file Articles of Organization with the appropriate state authorities in whatever state it will be organized in. Then, it is best to normally decide on the best management structure for the company. After that has been decided upon, the last and most important step would to create an operating agreement that will govern how the company will operate.
So, in conclusion, a Limited Liability Company (LLC) is simply a new hybrid business structure that combines the limited liability characteristics of a corporation with the pass-through taxation of a partnership, or sole proprietorship.