What Is An LLC?
Short for “Limited Liability Companies,” LLCs are one of the most common entity types used by small business owners due to their flexible structure. Another major benefit of LLCs is that they help protect your personal assets by “limiting” your liability as a company owner.
The IRS defines a Limited Liability Company as a:
“[B]usiness structure allowed by state statute. Each state may use different regulations, and you should check with your state if you are interested in starting
a Limited Liability Company.”
Forming an LLC involves filing a document called the Articles of Organization with your state’s secretary of state. Because of regional differences, the exact fees and administrative steps vary from state to state.
Regardless of which state you form an LLC, however, the following rules apply to all LLC business entities:
- Owners of an LLC are called “members.” Members may include individuals, corporations, other LLCs or foreign entities. However, they cannot be banks or insurance companies.
- An LLC can be formed by one or more members. There is no maximum number of members.
- There cannot be more than one active LLC with the same name in the same state.
- For federal tax purposes, an LLC must choose to be treated as a Sole Proprietorship, Partnership or Corporation. Otherwise, it is disregarded as an entity separate from its owner(s).
HOW DOES LLC TAXATION WORK?
If only one person is establishing an LLC, it is called a “Single Member LLC.” A Single Member LLC is taxed as a Sole Proprietor, meaning profits and losses are passed to the individual’s federal tax return (IRS Form 1040). If a husband and wife form an LLC together, some states (such as California) allow the business to be classified as a Single Member LLC for federal tax purposes.
If there is more than one member in the newly formed business, it is referred to as a “Multi-Member LLC.” By default, Multi-Member LLCs are taxed as Partnerships, meaning profits and losses are passed to each member’s individual federal tax return (IRS Form 1040).
Members of an LLC can also elect to be taxed as a Corporation:
- If electing for C-Corp taxation status, profits and losses are reported on IRS Form 8832.
- If electing for S-Corp taxation status, profits and losses are reported on IRS Form 2553.
LLC taxation also exists at the state level, with details, fees and requirements varying from state to state.
In California, for example, there is an income-based annual fee for any LLC earning more than $250,000 in a single tax year. However, there is also an annual flat tax of $800 for all LLCs — regardless of their earnings for the year. This $800 tax is one reason why some small businesses elect not to form an LLC. This is especially true if the benefits of liability protection do not outweigh the cost of the state tax.
To find out what state-specific LLC taxation rules apply to your business, visit your state’s Department of Revenue.