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What Is a Limited Liability Company (LLC)?
An LLC is a creation of the state. It 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. In addition, many states charge LLCs an annual renewal fee. California assess an annual franchise tax on LLCs. Some businesses cannot be organized as an LLC, such as banks, insurance companies, and nonprofit organizations.
Backround
The LLC form of business is a relatively new breed of business organization. For federal tax purposes, an LLC is not a recognized business classification. The IRS only recognizes three forms of 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 single-member LLC (SMLLC) is taxed as a sole proprietorship by default (automatically). A multi-member LLC MMLLC)is taxed as a partnership by default. Both a SMLLC and MMLLC may elect to be treated as either a C or S corporation for federal tax purposes.
Income Tax Filing
Assuming no election is made to be taxed as an S or C corporation, a SMLCC files Schedule C annually and an MMLLC files Form 1065 annually. An election on Form 8832 may be filed with the IRS to be taxed as a C corporation and Form 1120 would be filed annually. An election of Form 2553 may be filed with the IRS to be taxed as an S corporation and Form 1120S so would be filed annually. It is not required to file Form 8832 if Form 2553 is filed.
If an LLC elects corporation status, eithe C or S, LLC members who work for the business are treated as employees and subject to the same employment taxes and 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 because it provides the same limited liability protection as a corporation with less burdensome formalities associated with corporations, such as having an annual meeting.
Important!
Don't jeopardize your personal liability protection by running a sloppy operation. In other words, keep your books in order, maintain all business documentation (i.e. contracts, receipts) and don't commingle personal transactions with business transactions; keep a separate business bank account.