What Is an LLC and How Does It Work?

Here's a quick introduction to the LLC, to prepare you for exploring further aspects of LLCs, including their formation, operation, taxation, and how they contrast with other types of business entities.

What is an LLC?

A limited liability company is a type of business entity that is authorized by state law. A relatively recent creation, the LLC was designed to have some of the benefits of a corporation, but with less formality.

One of the main benefits of both a corporation and an LLC is that all of the owners have limited personal liability for the debts of the business.

The owner's personal assets (home, car, personal bank accounts, etc.) generally are not subject to attachment to pay business debts, including for lawsuits against the business. This limitation of liability is not available to sole proprietors or general partners in a partnership.

State laws typically require corporations to hold annual shareholder meetings, keep minutes of those meetings, and file various types of reports. At one time, many states would only allow the creation of a corporation if there were at least three owners—although most, if not all, states now allow single-owner corporations.

The LLC was devised to avoid many of the requirements of a corporation, while offering limited liability protection for the owners.

LLC formation

Each state has its own laws governing limited liability companies, but generally, an LLC is formed by filing some type of document with the state agency regulating business entities—very often the Secretary of State. The form, frequently called the Articles of Organization or Certificate of Formation, provides basic information about the LLC.

Many LLCs also create an operating agreement, setting forth details about the business, such as the initial contribution of each member—which is another name for "owner" in an LLC, the percentage of profits and losses to be allocated to each member, and the voting rights of each member. Unlike corporations, LLCs do not have shares of stock.

LLC structure and operation

There are two ways in which the structure of an LLC is classified:

• Ownership structure. An owner of an LLC is called a "member." This is similar to a shareholder in a corporation. If there is only one member, it is known as a single-member LLC. If there are two or more members, it is known as a multi-member LLC.
• Management structure. The day-to-day operation of the business is controlled by "managers" of the LLC. Managers are similar to the officers of a corporation. Members of an LLC may also serve as managers, in which case it is called a member-managed LLC. This is more common in single-member, and small multi-member, LLCs. If members of an LLC hire non-members as managers, it is called manager-managed, which is more common in larger, multi-member LLCs.

The LLC members make major decisions, whereas the managers conduct the day-to-day operations. Property is owned in the name of the LLC. If you decided to open a franchised business, the franchise would be in the name of the LLC. In most states, an LLC is not required to hold annual meetings of the members, or to keep minutes of meetings.

LLCs and taxes

An LLC has a choice as to how it will be taxed. Unless certain forms are filed with the Internal Revenue Service (IRS), a single-member LLC will be taxed as a sole proprietorship, and an LLC with two or more members will be taxed as a partnership. Both single-member and multi-member LLCs can choose to be taxed as a corporation by filing the appropriate form with the IRS. A choice can also be made to be taxed as either a C corporation or an S corporation.

The series LLC

A few states have created what is called a "series LLC." This allows the creation of one LLC, which is divided into two or more subdivisions or “series." Each series has its own limitation of liability, members, and managers.

For example, if you own several rental properties, you could form one LLC, but put each property in a separate series. Or, if you owned several franchised restaurants, each location could be a separate series. However, the law varies significantly from state to state, and the series LLC is currently only available in Alabama, Delaware, Illinois, Indiana, Iowa, Kansas, Minnesota, Missouri, Montana, Nevada, North Dakota, Oklahoma, Tennessee, Texas, Utah, Wisconsin, and the District of Columbia.