A limited liability company (LLC) is a legal business entity that provides some liability protection (like a corporation) and other features similar to a partnership. The owners of an LLC are called members, and LLCs can have several different types of owners, including some other business types.
This article describes how a limited liability company works and what types of owners the business may have.
- For tax purposes, there are two types of LLC memberships: a single-member LLC with one owner and a multiple member LLC with several owners.
- Some states require that the members of an LLC be identified on the registration document.
- The members of the LLC have limited liability for debts, obligations, and liabilities of the business.
- A single-member LLC is taxed as a sole proprietorship, while a multiple-member LLC is taxed as a partnership.
LLC Membership Requirements
An LLC is formed by registering with a U.S. state by filing articles of organization or similar document, depending on the state. The federal government, including the IRS, is not involved in forming an LLC.
There are two types of LLC memberships for tax purposes, depending on the number of members: a single-member LLC with one owner and a multiple member LLC with several owners. States don't distinguish between these two types when an LLC is registered; they are only relevant when it comes time for the business to file its income tax return.
Almost any organization can be a member of a multiple-owner LLC, including:
- Foreign entities
- Other LLCs
- Pension plans
A single-member LLC can be owned by a corporation or partnership, and foreign liability companies (those formed under the laws of another state) may have different qualifications for LLC membership. Some states require that the members of an LLC be identified on the registration document while other states do not
Professional LLCs: An Exception
A business forming as a professional LLC (PLLC) is restricted on the types of owners it can have, and some states don't allow PLLCs, Typically, only certain licensed professionals, like doctors, attorneys, or accountants, can form PLLCs. However, states differ in the types of professionals they allow as LLC members. The members usually must be identified and their professional licenses must be examined and approved when the company is formed.
Liability of LLC Members
The members of the LLC have limited liability for debts, obligations, and liabilities of the business. Limited liability doesn't mean that business owners have total immunity from any liability. It only means that the liability of the individual member is limited to their investment in the business.
LLC members do have personal liability if they have personally guaranteed loans or other debts or they act outside the bounds of their duties for the business. For example, limited liability can't protect a member who steals from the business or who harasses someone.
Management of LLCs
As with any other type of business, there must be someone in charge of the LLC for day-to-day and long-term decisions. The members can choose to manage the LLC themselves, or they can designate or hire a manager or managers.
The management of the LLC is usually spelled out in the application with the state and also in the LLC operating agreement. Whoever has administrative responsibilities for the LLC's finances and operations has general liability (not limited liability) for their administrative decisions and actions.
If the members decide to manage the LLC themselves, they can set up the management any way they like. There is no formal board of directors structure required, but it's a good idea for the LLC members to meet formally at least annually and to keep records of the decisions they make at their meetings.
LLC Member Taxation
The members of an LLC are taxed based on the number of members. Here's what that means: A single-member LLC is taxed as a sole proprietorship, which means that the sole member's taxes are determined by the net income on Schedule C and then passed through to the member's personal tax return.
A multiple-member LLC is taxed as a partnership, so each member's share of the net income or loss is passed through to the member's personal tax return. In a multiple-member LLC, the operating agreement determines each member's share in the duties of the business and in the profits and losses of the business. An LLC can also elect to be taxed as a corporation or S corporation, and the members then would pay tax in the same way as corporate shareholders or S corporation owners.
LLC members that are individuals are considered self-employed and not employees. They must pay self-employment tax on their share of the business net income.
Frequently Asked Questions (FAQs)
What determines the ownership of an LLC?
When an LLC is formed, it can decide who can become a member (owner) of the business, but it must conform with state and federal laws. States differ in their requirements for ownership of LLCs. The qualifications for ownership of a specific LLC should be spelled out in the company's operating agreement.
Professional LLCs (PLLCs) are a special case. States that allow PLLCs restrict ownership to specific types of professionals. Some states don't have a PLLC business type, but they allow licensed professionals to form a regular LLC. Illinois, for example, allows businesses to form a standard LLC for professional services if all the members are licensed.
How can a corporation become a member of an LLC?
One company can buy another and retain the company's previous legal form. If an LLC is owned by another business, it is typically set up as a subsidiary of the parent company, often a corporation. The parent company owns and controls the subsidiary (the LLC). A parent corporation may hold several LLCs for different purposes.
In real estate, for example, a corporation may own several LLCs, each for different properties, to separate the liability for one from the liability for another. The Supreme Court (in United States v. Bestfoods) said that a parent corporation isn't liable for the acts of its subsidiaries.
Do LLC members have titles?
LLC managers typically don't have titles like "Chief Executive Officer (CEO)," and an LLC doesn't have a board of directors like a corporation does. However, some members of an LLC have titles, depending on whether or not they participate in the management of the business.
LLCs can be managed by a member or a non-member. The non-member manager is usually a professional manager or management organization. In some cases, a group of LLC members can manage the business. A solo member who manages an LLC can be called a member-manager or managing member.