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What is an Limited Liability Corporation?

A limited liability company (or LLC) is not a corporation, but a hybrid business entity. It combines the advantages of a partnership and a regular corporation. Even though an individual must file paperwork with a state agency to create the LLC, which includes filing membership and operating agreements, the organizational structure is still more similar to a partnership. Rather than shareholders, an LLC has owners. Essentially, the partners become the “owner” of the LLC.

Each state has adopted their own rules regarding the formation and terminology of LLCs.

How to Form an LLC

To form an LLC, a business organization must complete, file, and submit the appropriate filing fee with the application to the appropriate state agency. Membership interest in the LLC is usually set up by percentage. For example, in an LLC with five owners who have invested equally in the business, each would normally have a 20% membership interest. These five owners will share in the profits of the LLC consistent with their percentage of ownership interest. Their interest is not based on stock holdings, but in their membership interest.

Understanding the Terminology When Forming an LLC

Because rules vary from state to state, so will the terminology regarding the formation of an LLC. Instead of partners, owners are usually called members. They are, however, sometimes referred to as shareholders, because they do own a share of the organization; however, they are not shareholders like the ones of a corporation. Shareholders in a corporation purchase stock to obtain their interest in a corporation. In contrast, an LLC may not issue stock. Any shareholders are actually members with a personal ownership interest in the LLC. Their interest does not stem from the purchase of stock, but from their actual interest in the formation of the LLC.

Benefits of Forming an LLC

Many businesses form LLCs for the limited liability and tax benefits. Compared to shareholders in a major corporation, shareholders or members of an LLC are more prone to the piercing of the corporate veil. This is a principle where the member has engaged in such fraudulent behavior that they can no longer hide behind the LLC protection. The exposure is different because a member is more engaged and involved in the day-to-day operations of the LLC. Shareholders of major corporations are more concerned that their stock stays at a certain level and that they get a good return on their investment.

LLC Taxation

One main advantage of a limited liability company rests in how the IRS treats the business under tax rules. Usually, an LLC is taxed as a partnership or a sole proprietorship, which means that the LLC pays no federal income taxes. The profits and losses are passed through to the members. Each member reports his or her share of profit or loss on his or her personal tax return. If each member owns 50 percent of the LLC, then each member will be responsible for paying 50 percent of the federal income taxes. Because only the partners or members are taxed, owners tend to avoid double taxation that would regularly apply to a corporation. In a corporate setting, the corporation would be taxed once for their profits, and then any recipients of profits (like shareholders) would also be taxed on their disbursements. With an LLC, owners are only taxed once under federal tax rules.

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Eldessouky Law - 2016 - 2021.
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