Limited liability company: de­f­i­n­i­tion of the legal structure

Would you like to start a company? The­o­ret­i­cal­ly, there are many legal forms to choose from. Liability, the required start-up capital, and formal aspects, are important criteria that you should take into account when deciding on a specific legal form. LLCs are one of the most important business types in America today and you don’t even need to be an American citizen to start one! But what exactly is an LLC and what are the ad­van­tages and dis­ad­van­tages?

An LLC is the least complex business structure and unlike an S cor­po­ra­tion or a C cor­po­ra­tion, its structure is also really flexible. The members cannot be held per­son­al­ly reliable for any debts or li­a­bil­i­ties the company might incur, which means that owners are protected from lawsuits and bank­rupt­cy. If the company goes bankrupt, the members don’t have to sell any of their pos­ses­sions to cover the set­tle­ment.

LLCs are a kind of hybrid company, since they combine char­ac­ter­is­tics of a cor­po­ra­tion and a part­ner­ship or sole pro­pri­etor­ship. The fact that it is limited liability makes it similar to a cor­po­ra­tion, but the flow-through taxation to the members makes it similar to a part­ner­ship. The LLC itself doesn’t pay income tax. Instead, the owners report any profits and losses on their personal tax returns.

All members of an LLC put money into the business to get it off the ground. This amount is known as a capital con­tri­bu­tion or a con­tri­bu­tion to the ownership. By giving this capital con­tri­bu­tion, it means you now have a share in the LLC, which in turns gives you the right to a per­cent­age of the profits that the company makes, but also to any losses it might incur. If you are the only person running the company then you have 100% of the ownership, but if there are several owners, the amount of shares each person has is usually de­ter­mined by a formal operating agreement. You can read more about this in our article titled “Creating an LLC”. The con­tri­bu­tions don’t nec­es­sar­i­ly have to be money, they could also be property, for example. The members must agree on how much the non-cash item is worth.

The initial capital con­tri­bu­tions can be any amount, but generally, they are enough to cover startup expenses and assets. If you aren’t able to make a con­tri­bu­tion, this could land you in hot water regarding legality and taxes, since you don’t have a personal risk in starting your business.

Making the con­tri­bu­tion in the first place is very easy: you simply have to write a check and deposit it in your new business account. Depending on what your business is, a few hundred dollars might be suf­fi­cient to get it up and running.

It’s very important to follow the rules con­cern­ing LLCs, otherwise you could find yourself in legal trouble if the limited liability of the company is com­pro­mised. When every­thing goes to plan, members are shielded from the company’s debts and most lawsuits. The only exception is that LLC members could be liable for any employee claims that occur, such as work accidents.

If an LLC has to close, members will only be liable for the amount of money they invested. If an LLC goes bankrupt, members won’t have to fear losing any personal items.

Member will lose their limited liability if they commit fraud using the company, or mix this business with their own business. They also lose this liability if they try to sabotage the company in any way.

Similar to cor­po­ra­tions, LLCs also have certain titles when the business is more than a single member limited liability company (SMLLC). As with the running of the LLC, these titles and roles are also rel­a­tive­ly informal. There are two main titles for an LLC: members and managers.

The members are the “owners” (similar to how a cor­po­ra­tion has share­hold­ers). The members are expected to choose the manager and there isn’t a limit to how many there can be: most states even allow single-member LLCs. How much in­volve­ment each member has depends on what was agreed upon in the Articles of Or­ga­ni­za­tion.

The managers are elected by the LLC’s members. The manager is the person who runs the business and acts as the contact person for the public. They have the authority to make day-to-day decisions to keep the business running smoothly. The number of managers depends on the number of members and the size of the company. Having managers isn’t com­pul­so­ry though: the members may decide to manage the company equally.

An LLC is not a taxing entity and isn’t rec­og­nized by the Internal Revenue Service for tax purposes. It can be taxed as a part­ner­ship or a cor­po­ra­tion (for several members), or as an entity separate from its owner (for a single-member LLC).

LLCs with a sole member are taxed as sole pro­pri­etor­ships. Schedule C needs to be filled out, which includes the LLC’s income, expenses, and net income. The net income entered in Schedule C needs to be entered in line 12 of the owner’s personal tax form (usually Form 1040). Despite this, the owner and the LLC still remain separate entities when it comes to taxes.

If an LLC has more than one member, then it’s normal for it to be taxed as a part­ner­ship. Taxes aren’t paid directly to the IRS; the in­di­vid­ual partners actually pay tax depending on the size of their share in the LLC. The part­ner­ship needs to fill out Form 1065, then a Schedule K-1 is prepared for each of the partners, which contains the company’s profits and losses. The K-1 is be filed with the partner’s own tax return, and the gain/loss is shown on Form 1040.

All busi­ness­es pay federal income taxes, and most states pay state income tax depending on whether the par­tic­u­lar state imposes it or not. Your state’s de­part­ment of revenue can reveal how you can expect your business to be taxed. There are two factors:

• What is the tax based on? The majority of states use the federal income tax liability as the basis, but some states choose to alter the basis for the tax that they impose.
• How does the LLC’s tax clas­si­fi­ca­tion affect the state income tax? The clas­si­fi­ca­tion refers to whether your company is sole pro­pri­etor, part­ner­ship, cor­po­ra­tion, etc.)

A limited liability company might be the least complex business structure, but it doesn’t come without its drawbacks. We’ve compiled a list of the pros and cons of LLCs so you can decide whether this business structure is for you.

• Easier taxes: You don’t need to file a corporate tax return, since LLC owners report profit and loss on their personal tax returns. This also means that double taxation can be avoided.
• Less paperwork: LLC are less stringent meaning there is less paperwork to fill out. The company will be governed by the default rules in your state.
• Legal stability: The “limited liability” in the name means that you aren’t per­son­al­ly re­spon­si­ble for any debts the company might incur.
• Increased cred­i­bil­i­ty: Partners and suppliers may favor your business over others since more com­mit­ment is shown.
• Flexible man­age­ment structure: The owners can decide to implement any or­ga­ni­za­tion­al structure.

• Limited potential for growth: Owners aren’t allowed to dis­trib­ute shares to attract investors.
• Lack of uni­for­mi­ty: Different states treat LLCs dif­fer­ent­ly. It may be confusing to abide by all the rules if you operate across multiple states.
• Role confusion: LLCs don’t have specific roles within the companies, so it can be difficult to know who is re­spon­si­ble for what. An LLC Operating Agreement can clarify the roles.
• Difficult to transfer ownership: All current owners must approve any new owners and any al­ter­ations made to the owner shares.

Click here for important legal dis­claimers.