A limited liability company (LLC) is a business entity that combines the limited liability protection of a business corporation with the flexible tax and organizational structure of a partnership.
Because LLC have features of both corporations and partnerships, it is called a “hybrid” entity.
To highlight that LLCs are not corporations, the terminology of LLCs is different: the “owners” of an LLC are called “members,” while the persons who are managing the company are called “managers.” Unlike the more rigid rules of a corporation, an LLC is not even required to designate managers: in a one or two person LLC, the members can also be the managers. In a larger LLC, though, having all the owners also have the ability to obligate the company on their own signatures is a risk, and therefore having specific managers in charge becomes a wise idea.
Tax Note: Unlike shareholders in a C corporation, LLCs are not taxed as a separate business entity, unless they choose to do so. Instead, all profits and losses are “passed through” the business to each member of the LLC. LLC members report profits and losses on their personal federal tax returns, just like the owners of a partnership would.
Important Terminology for LLCs
Why Are LLCs so Popular?
Except for New York, there are two new LLCs formed for every new corporation. There are two main reasons for this:
1. An LLC can be as simple or complicated as the owners want. don’t like annual meetings? Fine, there is no legal requirement for an annual meeting, so if the owners don’t want one, they don’t need one. Don’t like long complicated agreements? Well, there should be some type of operating agreement or the LLC can be considered a sham, but it does not need to be very long – unless the owners want it to be. In most states, there are very few mandatory requirements for LLCs.
2. An LLC with one member is considered to be a sole proprietorship for tax purposes, while an LLC with more than one member is automatically considered to be a partnership. For a single-member LLC, this means that the LLC doesn’t even have to file its own tax return: the profits and losses are reported on the owner’s Form 1040. If being a partnership or sole proprietorship is not useful, filing a one-page form with the IRS converts the LLC into a C or S corporation, and therefore treated exactly as a corporation. It’s kind of like the “Get Out of Jail Free” card in “Monopoly.” This option can only be used once in 5 years without penalty, though.