Key Takeaways

  • An LLC structure protects owners' personal assets and offers operational flexibility.
  • LLCs can be member-managed or manager-managed, impacting day-to-day control.
  • Pass-through taxation applies, but LLCs can elect corporate taxation.
  • Variations exist like Series LLCs and Professional LLCs for special cases.
  • Formation requires careful drafting of Articles of Organization and an Operating Agreement.
  • Business liability insurance is crucial for protecting against third-party claims.
  • LLCs must maintain compliance with state filings and financial management practices.

What is the Structure of an LLC?

A limited liability company (LLC) structure is the simplest form of legal business structure for business operations. An LLC gives an owner peace of mind by offering protection from any kind of personal liability for business-related debts, just like a corporation.

Setting up an LLC business structure can be handled by a good legal counsel, with an owner’s input about the kind of details to include in the structure set-up. The two ways that limited liability companies can be set up are the following: member managed or manager managed. This choice of ownership protocol gives owners an opportunity to run the company in the way they prefer most.

For owners, there is far more choice and flexibility in a limited liability company. For owners intimidated by the thoughts of turning their small business into a corporation, then choosing to set up as an LLC is the path to take. An LLC is much easier to set up than a corporation, and it provides more flexibility along with ownership protection. The owner can choose to operate as a single person entity, with minimal formality, or can choose to set up the company similar to that of a corporation. In this LLC setup, the owner would designate persons as officers and directors of the firm.

An LLC acts in a way that offers advantages to a company for taxes, profits and losses for its owners. On the LLC owner’s tax returns, they can report this Profit & Loss and taxes on their personal tax returns, like they would if had they owned a sole proprietorship or partnership.

Key Components of an LLC Structure

An LLC structure typically includes members (owners), managers (if applicable), and the LLC itself as a separate legal entity. Members invest capital into the business and share profits and losses according to the operating agreement. In member-managed LLCs, all members participate in daily operations, while in manager-managed LLCs, members appoint one or more managers to handle the business's day-to-day activities​.

Limited Personal Liability

Limited Personal Liability is the term used to describe the protection for owners in a limited liability company. If creditors come to a business owners of an LLC for a debt or a financial claim then the owner would be protected from personal liability. LLC owners should only lose the money they've put into in the LLC.

There are exceptions to this overarching rule. If you’re the owner of an LLC, you can be held personally liable if you directly and personally causes an accident to another individual. Another instance might be if the LLC owner personally guarantees a business debt or bank loan to another individual.

Another exception might be if the LLC is found to be in default, or if the LLC fails to deposit withholding taxes from its employees. Owners also cannot treat the LLC like their own personal piggy bank and conduct financial affairs that are intentionally deceitful or untrustworthy. If this happens and an LLC gets taken to court, the owner can find himself in difficult trouble.

Owners must treat the LLC as a separate business unit from their own personal finances. If they don’t utilize it as a separate business, a court may think otherwise and find them in contempt of their business intentions. The court may find that the owners are acting as individuals and may find them liable personally for his or her actions.

Make sure you and the co-owners act legally and fairly, adequately fund your LLC, keep personal business and LLC business separate, and form an operating agreement.

Exceptions to Limited Liability Protection

While an LLC protects members from personal liability, this shield can be pierced if members engage in fraudulent activities, commingle personal and business finances, or personally guarantee business loans. In such cases, courts may hold individuals personally responsible for the LLC’s debts and obligations​.

LLC Taxes

The IRS considers an LLC a pass-through entity similar to a partnership or sole proprietorship. It’s not considered as separate from the actual LLC owners for tax purposes. That means that taxes are handled via the LLC owner’s personal tax returns and using an informational form 1065 for the IRS. This form sets out in detail how much profit or loss is shared by the members of the LLC. Each LLC member has to share this information with the IRS when reporting income.

Here are some of the advantages and disadvantages of owning an LLC:

Pros

  • Owners can choose the structure in which they can be taxed
  • The costs will be lower to owners for paperwork and filing
  • LLCs can be formed with just one owner, but the owner can have many members
  • Members are protected from any debts or claims to the LLC

Cons

  • Owners cannot pay wages to self
  • It’s hard to attract investors to put money into an LLC
  • Since the owner can have many members, this can be considered a con to an LLC

Tax Classification Options for LLCs

LLCs have flexibility in their tax treatment. By default, single-member LLCs are taxed as sole proprietorships and multi-member LLCs as partnerships. However, LLCs can elect to be taxed as S corporations or C corporations by filing Form 8832 or Form 2553 with the IRS. Electing corporate tax treatment may offer advantages like reduced self-employment taxes​​.

LLC Management

Management of most small LLCs have an equal say and participation for the management of the LLC business. This is how the LLC structure of member management works, when the members decide to make equal decisions for the LLC.

Alternatively, LLCs are also run as managed management - in which the owner designates another person in the LLC or maybe an outsider to be responsible for running the LLC. These people are able to be involved in management decisions and act as the LLC agents as needed.

Forming an LLC

To form an LLC, a person has to file articles of organization with the state or county in which the LLC will do business. The LLC application usually includes name, address, contact information and more for the person for whom the LLC is organized around.  This person is also sometimes called the registered agent. The LLC must also have an operating agreement. This document doesn’t need to be filed like the articles of organization, but the LLC should have it ready for any state inspection. This operating agreement outlines the members of the LLC, their rights and responsibilities, their share of the business and their share of profits and losses.

Basic Structure of the LLC

LLCs offer a lot more choice and flexibility. In an LLC, a manager can take care of the LLC’s day-to day-operations. This can include activities like developing business partnerships, paying bills and invoices, hiring new employees or firing others, obtaining loans, seeking to buy other businesses and more.

Duties and Rights of LLC Members and Managers

The duties of LLC members and managers typically include loyalty, care, and acting in the best interests of the company. Rights often involve voting on major decisions, inspecting company records, and receiving distributions. These rights and obligations should be outlined clearly in the operating agreement to prevent internal conflicts​​.

Single Member LLC Taxes

LLC taxes can be filed for a single member. This process becomes simpler to handle for the LLC. The IRS sees the single member tax on LLC similar to that of a sole proprietorship. The official word used by tax authorities is ‘disregarded entities.’

Separate tax returns are not required of the business owner, but the owner should use a schedule C on the tax return. Conversely, a single member LLC can be taxed like a corporation if that tax route is seen to be more advantageous to the owner or owners.

Single-Member LLC Tax Advantages

A single-member LLC offers simplified taxation, as profits and losses are reported on the owner's individual tax return via Schedule C. Additionally, a single-member LLC may still choose corporate taxation for strategic reasons, such as benefiting from a flat corporate tax rate or planning for business expansion​.

Limited Liability Company

A limited liability company (LLC) is a corporate structure whereby the members of the company cannot be held personally liable for the company's debts or liabilities. In fact, this is the primary reason business people set up LLCs, in order to limit the main member’s personal liability.

The primary difference between a partnership and an LLC is that an LLC is designed to separate the business assets of the company from the personal assets of the owner, which has the effect of insulating the owners from the LLC's debts and liabilities. In the event of the death or bankruptcy of a LLC business owner, then the LLC needs to be closed.

Company

A company is defined as an entity that exists to engage in business operations. A company may be organized in various ways for tax and financial liability purposes. There are several types of companies, including sole proprietorships, limited partnerships, limited liability partnerships, limited liability corporations, S corporations and C corporations.

Limited Entrepreneur

LLC owners must be careful to not allocate more than 35% of the LLC's losses to limited entrepreneurs, otherwise the LLC would be classified as a syndicate and face different tax treatment.

Limited partners are similar to limited entrepreneurs in that they also do not play an active role in a company's management and cannot be held responsible for any debts the company incurs

Limited Company

A limited company (LC) is another form of incorporation. In this legal structure, the company shareholders take up the liability held by the company. In other words, the debts of the company are separate from those held by the shareholders.

If normal business activity brings about financial distress to the company, then creditors will not be able to seize the personal assets of the shareholders as a result.

LLC vs Limited Company (LC)

While both LLCs and limited companies (LCs) protect owners' personal assets, LCs typically exist in countries like the UK and have different compliance requirements. LLCs in the U.S. offer greater tax flexibility and management freedom compared to traditional LCs​.

Limited Liability

Limited liability is a facet of many legal company operations. This is a type of liability less than in dollar amounts than the amount originally invested by a partnership or a limited liability company. This feature remains high for investors as a leading reason to invest in public companies. Assets held by individuals in a business LLC or corporation cannot be seized to use in repaying debt obligations of the company. Partners in a partnership also have limited liability while the general partner has unlimited liability.

Variations of Limited Liability Companies

There are different types of LLCs tailored for specific needs:

  • Series LLCs: Allow for the creation of multiple "series" under one LLC umbrella, each with separate assets and liabilities.
  • Professional LLCs (PLLCs): Designed for licensed professionals like doctors, lawyers, and accountants who are required by law to use a specialized structure​​.

Business Liability Insurance

Insurance that protects a company and/or business owner in the event of a formal lawsuit or other third-party claim. Business liability insurance can provide you with greater insurance protection than is offered by your legal structure. New or additional insurance policies should contain an exclusions clause to minimize cost by avoiding duplications of coverage provided in other policies and/or to eliminate any unneeded coverage.

Terminating an LLC

Under many states’ laws, unless an operating agreement states otherwise, if a member wants to leave the limited liable company, that company will dissolve. The company’s members have to fulfill any outstanding business requirements, divide any assets and profits among themselves, pay off all debts, and then decide if they want to form a new LLC to continue the business with the remaining members. LLC operating agreements can avoid this type of sudden closure to a business by including "buy-sell," or buyout, provisions, which create guidelines for what happens if one member dies, retires, becomes disabled, or leaves the LLC to follow other interests.

Why LLCs Still Need Business Insurance

Even with limited liability, LLCs can still face lawsuits or claims that exceed the business's assets. Business liability insurance helps cover legal costs, settlements, and damages. Common types include general liability, professional liability, and product liability insurance. Proper coverage ensures that a lawsuit doesn’t bankrupt the business​​.

Firm

One of the details in forming an LLC is terminology. Using the word firm can be used for describing any kind of business operation that sells goods or services to make a profit. This can describe an LLC, a sole proprietorship, a corporation or other enterprise.

Here are some definitions:

  • A sole proprietorship is owned by one person, and consequently, that person is liable for all costs and obligations.
  • A partnership lets two or more individuals share in profits and liabilities for a business venture. The partners are liable for all business obligations, and they own everything that belongs to the business. Limited liability partnerships (LLP) are a common structure for professional firms, such as accounting, law and architecture firms. Partnerships do not pay income tax; it passes through to the partners. Partners are not considered employees for tax purposes.
  • A corporation can be owned by individuals or by a government.
  • A cooperative is similar to a corporation in that its owners have limited liability, but the difference is that its investors have say into the company's operations.

Forming an LLC: Steps to Get Started

Key steps to forming an LLC include:

  • Choose a unique business name that complies with state rules.
  • Appoint a registered agent to accept legal documents.
  • File Articles of Organization with your state’s LLC office.
  • Create an Operating Agreement outlining ownership and management structures.
  • Obtain necessary licenses and permits to operate legally.
  • Comply with state reporting requirements, such as annual reports and franchise taxes​​​.

Total Liabilities

Total liabilities refer to the amount of debts held liable by an individual or company. This number is found by adding up all liabilities, both short-term and long-term, along with typical corporation liabilities found on the company balance sheet.

The balance sheet will always show total liabilities that represent the entity’s total debt. Short-term liabilities are typically accounts payable, salary payable and rent payable. Total liabilities is a useful metric for analyzing a company's operations. The creditworthiness of an entity reflects the relationship of a business with total liabilities.

Unlimited Liability

Lastly, to understand the full extent of business liability, we come to unlimited liability business. This idea captures the responsibility for deb and liabilities held by an LLC’s joint owners. This is different from a limited liability venture, in that it can be repaid via seizure of the owner’s personal assets.

In other words, the business’ owners are equally responsible for liabilities and debt and their personal wealth could be used to cover an of the LLC debts.

Frequently Asked Questions

  1. What is the main advantage of an LLC structure?
    The primary advantage of an LLC structure is that it protects owners' personal assets from business debts while offering flexible taxation options.
  2. Can an LLC be taxed as a corporation?
    Yes, an LLC can elect to be taxed as an S corporation or C corporation by filing the appropriate IRS forms, which may offer tax-saving benefits depending on the business situation.
  3. What is a Series LLC?
    A Series LLC is a type of LLC that allows multiple independent divisions, each with its own assets and liabilities, to exist under a single master LLC structure.
  4. What happens if an LLC has no operating agreement?
    If there is no operating agreement, the LLC will be governed by the default rules of the state where it is organized, which may not reflect the members' intentions.
  5. Do single-member LLCs need an operating agreement?
    Yes, even single-member LLCs should have an operating agreement to formalize business practices and help maintain liability protection.

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