What is a Limited Liability Company (LLC)?

All About the Limited Liability Company (LLC)
••• gehring/Getty Images

The Limited Liability Company (LLC) is a fast-growing form of business in the U.S. In 2012, over 2 million LLC's filed U.S. tax returns., and that's just the LLC's with more than one member. If you are considering forming an LLC, here's what you need to know about this business form.  

What is an LLC? 

A Limited Liability Company or LLC is a legal form of business organization with daily activities like a partnership but with limited liability for the owners similar to a corporation. The liability of LLC members is limited to their investment in the business.

An LLC is NOT a Corporation

An LLC is sometimes incorrectly referred to as a Limited Liability Corporation. Although an LLC can elect to be taxed as a corporation (see below), an LLC is not formed as a corporation.

How to Form an LLC

An LLC is formed in the state in which it operates. An LLC is formed by filing Articles of Organization with the state in which you will be doing business. (A few states use a Certificate of Organization to form an LLC.) Although most states make it relatively easy to file LLC filing documents online, it's always best to have the help of an attorney to form an LLC. 

If your LLC does business in several states, you will need to set up a separate LLC registration in each state. The first, or main, LLC registration is called a domestic LLC, while the other state registrations are called foreign LLCs.

Along with the required state formation application, an LLC also should have an operating agreement, which defines the purpose of the LLC, how its members work together, and many other details that describe what happens in certain circumstances. 

LLC Ownership

The owners of an LLC are called "members" rather than partners or shareholders. The members draw up an operating agreement (similar to a partnership agreement) by which they run the LLC. An LLC can be owned by individuals, corporations, s corporations, other LLCs, trusts, and pension plans.

In addition to being owned by one or more individuals, an LLC can also be owned by another business entity, including a corporation or another LLC. 

LLC owners are not employees, so they do not

LLC Management

An LLC can be managed by either one (usually) owner or by a professional manager. If one of the owners is the manager, that person may receive pay as an employee.

LLC Taxation

An LLC is not recognized as a taxing entity by the IRS. Instead, LLCs are taxed as either a sole proprietorship or a partnership, based on the number of members. in either case, it is the individual owners who are taxed, not the LLC; the tax passes through to the owner's personal income tax return.

Types of LLC's

In addition to the common basic LLC type, there are two other types of LLC's you need to know about:

  • A Professional LLC (PLLC) is an LLC set up and owned by specific types of professionals. Typically medical professionals, accountants, engineers, and architects can form a PLLC. The list of professionals varies by state.
  • A Series LLC is a type of LLC that has a main LLC and other separate LLC's within it. They are segregated for liability purposes. Series LLC's are often used for real estate holdings, with each LLC in the series owning a different property.

A History of Limited Liability Companies

The limited liability company is a relatively new type of business legal entity in the U.S.

Other countries, primarily Germany and France, had similar types of organizations, and the U.S. LLC form is modeled after a Germany limited company called a GmbH. The first LLC in the U.S. was in Wyoming in 1977, but it took almost 20 years before other states enacted similar legislation.

It also took several years before the IRS determined how to treat LLC's for tax purposes. It wasn't until 1996 that a uniform set of laws governing LLC's was enacted. (Adapted from JRank's law library, which has more detailed information on the history of LLC's in the U.S. )

Disclaimer: The information in this article and on this site is not intended to be tax or legal advice; the author is not an attorney or tax professional. Each business situation is different, and taxes and laws change regularly. Before you make any decisions about business type, consult with both an attorney and a tax advisor.