What Is a Limited Liability Company?

A limited liability company is formed under state law by filing Articles of Organization and paying a fee to the state.

The formation fee varies from state to state. Many states charge an annual renewal fee. Some states, like California, assess an annual franchise tax on LLCs.

Some businesses cannot be organized as a limited liability company, such as banks, insurance companies, and nonprofit organizations.

Important points about a limited liability company:

  • An LLC is a creation of the state.
  • An LLC is a relatively new breed of business organization.
  • For federal tax purposes, an LLC is not a recognized business classification.
    • The following ARE recognized business classifications for federal tax purposes:
      • Sole proprietorship
      • Corporation
      • Partnership
  • Because an LLC is not a recognized business classification for federal tax purposes, there is no federal tax form for LLCs.
  • A limited liability company with two or more members is automatically taxed as a partnership.
    • Form 1065 is filed annually.
    • If an election is made on Form 8832 for the LLC to be taxed as a corporation, Form 1120 is filed annually.
    • If Form 2553 is filed, the LLC will be treated as an S corporation for federal tax purposes. It is not required to file Form 8832 if Form 2553 is filed.
    • If you elect regular C corporation or S corporation status, LLC members who work for the business are treated as employees subject to the same tax withholding rules as any other employee of the business.
  • A one-person limited liability company is automatically taxed as a sole proprietorship.
    • Schedule C or F is filed annually.
    • If an election is made on Form 8832 for the LLC to be taxed as a corporation, Form 1120 is filed annually.
    • If Form 2553 is filed, the LLC will be treated as an S corporation for federal tax purposes. It is not required to file Form 8832 if Form 2553 is filed.
    • If you elect regular C corporation or S corporation status, LLC members who work for the business are treated as employees subject to the same tax withholding rules as any other employee of the business.

Legal Implications of Operating as a Limited Liability Company

Because LLCs are a relatively new breed of business structure they may receive inconsistent treatment from state to state when it comes to litigation.

Only after years of many legal challenges and the resulting body of legal precedents will they be better evaluated from a legal standpoint.

Notwithstanding this lack of a legal track record, the limited liability company form of business remains a popular choice for many entrepreneurs.

IMPORTANT!

If you're serious about forming an LLC make sure you understand the proper way to operate it to ensure you don't jeopardize your personal liability protection and thereby put your personal assets at risk.

For example, you should never commingle personal and business funds in your personal checking account.

Run your business like a business!


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