Limited Liability Companies (LLCs)

The limited liability company (LLC) is a type of small-business organization that offers non-tax advantages over a partnership or corporation. Unlike a general partnership, an LLC protects its owners' personal assets from business creditors. Individual LLC owners' liability for business debts is limited to their ownership interest in the company; hence the name 'limited liability'. Additionally, an LLC can be run less formally than a corporation, and all owners can take an active role in the operation of the business without exposing themselves to personal liability.

The LLC, like a partnership or S corporation, is a 'pass-through' tax entity. (It can, however, choose either pass-through taxation or to be taxed like a corporation, although it's fairly unusual for a limited liability company to opt for the latter.) Owners (also known as members) report and pay taxes on LLC income on their individual tax returns and are responsible for filing estimated taxes. Because LLCs don't pay federal income tax, company income is not subject to dual taxation. It is taxed at only one level – to the members, who report their portion of the business income or loss on Schedule C of their individual tax returns. Multi-member LLCs must file Form 1065, U.S. Return of Partnership Income, and must also annually issue each member Schedule K-l, showing the member's annual share of the company's profit or loss. Only members actively working in the LLC must pay self-employment tax on earnings; passive investors are not required to do so. Single-member LLCs are treated as sole proprietorships for tax purposes and must report income on the owner's individual Schedule C.

Even though LLCs are not subject to federal income tax, the state where the company is located may impose its own taxes. Most states require annual tax reporting on their own state forms. The IRS (and likely the state taxing authority as well) can, however, collect delinquent LLC payroll taxes directly from company members.

To form an LLC, a federal Tax ID number must be obtained from the IRS, and a written Articles of Organization (also known as a Certificate of Formation or Certificate of Organization in some states) must be prepared and sent to the resident state's filing office, usually the Secretary of State. The articles may be a simple one-page form, similar to a corporation's Articles of Incorporation. Filing fees vary among individual states. Additionally, a written Operating Agreement (like the bylaws that govern a corporation) may also be required by some states. The operating agreement sets forth the internal rules for governing the LLC: voting rights, check-signing authority and other vital matters. Even if a written operating agreement is not required, it may still be a prudent choice to have one. Such a document could help to avoid or settle disputes about the management of company matters in the future. Similarly, although most states don't require LLCs to adhere to 'corporate' formalities such as keeping minutes, passing resolutions and holding annual meetings, it's nonetheless wise to formally document the company's major actions, such as electing to be taxed as a corporation, entering into an executive employment agreement, and other such activities.

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