Limited Liability Company (LLC)

A limited liability company (“LLC”) is a formal business entity made up of members (members can be individual people, corporations, other LLCs, or foreign entities) conducting business.

How it’s Formed: The business owners form the LLC by filing an organization document with the state’s corporate filing office, usually the Secretary of State. Some states call this document the “articles of organization,” some call it the “certificate of formation,” and others call it the “certificate of organization.” Usually, there is a filing fee and some states have other requirements, such as publishing a notice that you set up an LLC in two local newspapers. An operating agreement (also called an “LLC Agreement”) is recommended to set out the terms of the relationship between the LLC managers and members, but it is not necessary for filing. 

How it’s Taxed: An LLC with one member is considered a “disregarded entity” by the IRS meaning it is treated as a sole proprietorship and not considered separate from its owner, so the owner reports profits and losses of the business on their personal tax return and is also required to pay self-employment taxes (Social Security and Medicare). An LLC with two or more members is treated by default by the IRS as a partnership, so each partner reports their share of the business’s income or losses on their personal tax return and they are each required to pay self-employment taxes (Social Security and Medicare). The LLC can elect to be treated as a corporation (a C-corporation or an S-corporation) by the IRS for tax purposes by filing Form 8832, Entity Classification Election with the IRS. If the owners of the LLC elect to be taxed as a corporation, the LLC members would be considered shareholders of the corporation and be responsible for paying corporate taxes. There would be no requirement to pay self-employment taxes. 

Key Benefits

  • Can protect the members and employees and their assets against certain types of personal liability (though, members and employees may still be personally liable for certain claims, like those related to negligent acts and debts that they personally guarantee).
  • Doesn’t require the formalities associated with corporations like issuing stock or setting up a board of directors.

Key Downsides:

  • Some investors may be reluctant to invest in the business because they would become LLC members and responsible for reporting taxes on their personal tax return.
  • Some states require that the LLC be dissolved when a member leaves, goes bankrupt, or dies.