While you are familiar with the Limited Liability Company business entity, you may not realize there are different types of LLC business structures. In a recent live presentation to accounting and tax professionals, our own Amanda Beren walked through what an LLC is and the different types of LLCs in the U.S. If you missed it, fear not! You can watch it and I will cover the details in this article.
The LLC is among the most popular entity types for many reasons. Still, before registering any entity, it’s critical for business owners to understand the nuances of the business structure so they’re prepared for what’s involved in establishing it and keeping it compliant. The information Amanda shares comes from her 20 years of experience in business formation and it is a great starting point. As always, we recommend entrepreneurs talk with their attorney and other advisors for advice before they finalize their decision.
Limited Liability Company Basics
While the first Corporation was formed in the U.S. in 1813, the Limited Liability Company structure wasn’t created until 1977. Although the LLC is much younger (over 160 years more youthful) than the Corporation, it has become a top choice for many business owners.
The LLC is a business structure formed under specific state statutes that formally organizes a company as a business entity. Typically, the paperwork to register an LLC is called Articles of Organization. All states now offer the option to form a business as an LLC. Start-up requirements differ from state to state and the ongoing compliance requirements also vary.
Because an LLC is a legal entity in its own right, it protects its owners from personal liability (under most circumstances). Also, operating as an LLC offers various other advantages, such as simplicity, tax treatment options, management flexibility, and potentially more financing opportunities than Sole Proprietorships and Partnerships.
For more information about the potential benefits of the LLC, please read our article Benefits of Forming an LLC.
Different Flavors of the LLC Business Structure
Single Member LLC
A Single Member LLC has one owner who has full control of the entity. That owner is considered both the LLC member and manager. The LLC is considered a disregarded entity by the IRS and is, by default, taxed as a Sole Proprietorship, as I described earlier.
The owner of a Single Member LLC reports business income and expenses on their personal tax form using Schedule C (or E or F, depending on their business activities), just as a Sole Proprietor would, and pays taxes to the IRS based on their personal income rate.
Multi-Member LLC
A Multi-member LLC has two or more owners who share control of the company. The members must decide if they want the LLC to be member- or manager-managed. In most states, it is taxed as a Partnership. However, there are some exceptions where it will be taxed as a Sole Proprietorship if the owners are a husband and wife.
In an LLC with more than one member, each member pays income tax based on their percentage of ownership, similar to a Partnership. The business must file a Form 1065, U.S. Partnership Return of Income and send each member a Schedule K-1. Members then must report the amounts shown on their Forms K-1 on their own Forms 1040.
Although most states don’t require one, every LLC should have an operating agreement that spells out in detail each member’s responsibilities in running the company, their decision-making authority, and how profits will be distributed. If the business is manager-managed, it should have a detailed agreement that states the responsibilities of the manager, how management decisions will be made, how managers are removed, and other pertinent information.
It’s important to check your state’s rules. For instance, California (CorpNet’s home state) requires an LLC to have an operating agreement. Although the LLC doesn’t have to file its operating agreement with any government agencies, it must maintain it at the office where it keeps its other LLC records.
Member-Managed LLC
When members manage the business, it’s called a Member-managed LLC and when a non-member runs it, it’s known as Manager-managed. An LLC’s operating agreement should define members’ and managers’ roles and responsibilities.
A Member-managed LLC is when all members actively participate in running the business. Most multi-member LLCs choose the member-managed LLC option, and most states consider an LLC to be member-managed unless specified in the company’s Articles of Organization.
Manager-Managed LLC
A Manager-managed LLC is when only one or more designated nonmembers, specific members, or a combination of the two, handle running the business’s daily operations.
For example, say I’m opening a restaurant but don’t have much experience in the food service industry. In that case, I might hire John, who knows all the ins and outs of the industry, to manage my eatery. As the manager, he has the power to do many things on behalf of my LLC—open business bank accounts, obtain permits, apply for business licenses, hire employees, etc. However, he cannot make changes to my restaurant’s business entity or make other high-level strategic decisions.
Managers who also are members normally have voting rights and the ability to negotiate loans or handle other business, financial, and operational tasks. Non-managing members are still owners but remove themselves from the direct operations of the business. That arrangement works well in cases such as when family members invest in the business with the expectation of financial reward but not wanting to be directly involved with operations.
Domestic LLC
Every LLC must be registered as a domestic entity somewhere. In other words, it needs a home state (a state where it’s domiciled). That’s where it has registered its formation documents (Articles of Organization).
For example, a company registered as an LLC in Michigan doing business in that state is operating as a Domestic LLC there.
Foreign LLC
If a Domestic LLC in one state wants to do business in another state, it must file for foreign qualification with the Secretary of State there. It is then considered a Foreign LLC in the other state.
For example, if a Domestic LLC in Michigan wants to conduct business in Illinois, it must foreign qualify in Illinois to be a Foreign LLC there.
It’s important to understand that “doing business” in another state doesn’t mean selling your products or services to customers there. It varies from state to state, but doing business usually refers to these types of activities:
- Opening a bank account in a state other than where the business is registered
- Operating an office, store, manufacturing facility, or distribution site there
- Owning business property in another state
- Selling in a different state through salespeople or distributors
- Reaching a sales or revenue threshold in a state that constitutes having nexus.
Some LLCs register in a state other than where they’re located to take advantage of business-friendly tax laws. That means if the company wants to conduct business in its home state, it will need to register there as a Foreign LLC. That involves paying two sets of filing fees; having two registered agents, which is someone designated to receive legal correspondence on behalf of the business; and paying annual fees and filing annual reports in two states.
Professional Limited Liability Company (PLLC)
Most states offer a Professional LLC option for professionals such as doctors, lawyers, accountants, engineers, architects, and chiropractors. In fact, some states require that business owners who need professional licenses to conduct business form a PLLC rather than a regular LLC. Some states require that a certain percentage or all of a PLLC’s members are licensed in the same profession.
Generally, in states that require PLLCs, the state licensing board for the profession must approve the articles of organization and other required paperwork before they are submitted to the Secretary of State. Difficulties arise when a licensed member dies, loses their license, or wishes to exit the PLLC. In some cases, the entity must be dissolved (and perhaps recreated if the remaining members want to continue to operate the business). Transfer of ownership in a sale may also have restrictions at the state level. Also, because not all states offer the PLLC structure, it may be more difficult for a PLLC’s members to expand their services across state lines. If they wish to conduct business in a state that doesn’t recognize PLLCs, they will have to form a different entity in that state.
A PLLC provides the same protections and flexibility as a standard LLC but does not protect a professional from being liable from their own malpractice. If a doctor commits malpractice and causes harm to a patient, for instance, they can be sued by the patient, putting their personal assets at risk. Other doctors in the company, however, are protected from being held personally responsible for their partner’s actions.
Low-Profit LLC
A Low-Profit LLC, or L3C, is a relatively new model that’s required to provide a service or product that benefits the public. The entity type is only available in about a dozen states at this point but is becoming more popular among various types of organizations, such as farmers markets, affordable housing developers, and certain research organizations.
L3Cs are for-profit businesses and are not tax-exempt, but making a profit must be secondary to the primary objective of providing a service to the public. They were primarily created to make it easier for socially conscious entrepreneurs to attract funding from private foundations.
This variation is formed the same way as standard LLCs, must follow the same compliance rules, and provide the same protections and flexibility. As the number of socially motivated businesses increases, many experts feel that more states will allow for Low-Profit LLCs.
Series LLC
Series LLCs, which got their start in Delaware, are not permitted in every state, although the number of states allowing them is increasing.
Popular among real estate investors and other companies that operate multiple lines of business, a Series LLC consists of an umbrella (a.k.a. a parent LLC) and one or more sub-LLCs (or child series). Each sub-LLC operates as a separate business while being maintained by the primary entity.
Series LLCs are set up to protect each line of business from risks encountered by the others. A real estate investor with eight rental properties, for instance, may set up a Series LLC with eight sub-LLCs, each representing one of the properties. If the investor is sued because of an issue with one of the properties, the other properties are protected because they operate as separate businesses. Typically, members of the Series LLC parent company share profits and losses based on their ownership percentages or according to other terms set forth in the LLC operating agreement.
S Corporation Election for an LLC
If an LLC meets the IRS eligibility requirements, it may elect to be treated as an S Corporation for income tax purposes.
An overview of the S Corporation election:
- This is requested by filing IRS Form 2253.
- For an entity to elect S Corporation status, it must be a domestic company, meaning formed within the US, with owners who are individuals, certain trusts, and estates.
- Non-resident aliens, Partnerships, and Corporations may not be shareholders of an S Corporation.
- An S Corporation may not have more than 100 shareholders and the company may only have one class of stock.
- The S Corporation election is a federal election that impacts federal income tax, although many states recognize it at the state level as well.
How the S Corporation tax treatment differs from the LLC default treatment:
- Both the LLC and S Corporation are pass-through entities. This means the business entity’s profits and losses flow through to the business owners’ personal tax returns and income is taxed at the appropriate personal tax rates.
- The main difference between them is that LLC members pay themselves by taking money out of their share of the business profits. As in Sole Proprietorships and Partnerships, the business owners are not considered company employees and do not get a paycheck from which income tax, Social Security, and Medicare taxes are withheld. Therefore, they pay self-employment tax (Social Security and Medicare taxes) on all of their profits.
- In an S Corporation, all shareholders who do substantial work for the company are considered employees and must be on the payroll. Therefore, they receive paychecks from which income and FICA (Social Security and Medicare taxes) are withheld. With S Corporation election, the owners pay those taxes only on their wages and salaries, not on profit distributions they receive from the company. So, this potentially lowers the individual owners’ personal tax burden.
- An S Corporation must file an information tax return (Form 1120-S) even though it is not subject to income taxes at the entity level for federal purposes.
- Certain states also impose an LLC tax or fee, so research your state’s requirements.
LLC Formation and Compliance
Now that you’ve got a crash course in types of LLCs and the nuances of each, let’s take a look at the main steps involved in forming an LLC and what’s required to keep the entity in good standing.
Steps to form an LLC:
- File articles of organization with the state
- Designate a registered agent
- Create an operating agreement
- Obtain an EIN (employer identification number)
- Request foreign qualification if operating in multiple states
- Obtain business licenses and permits
- Register for sales tax (applies to most states)
- Register for payroll taxes (if you have employees)
LLC compliance requirements:
- Maintain a registered agent
- File an annual report
- Hold an annual meeting and record minutes of meetings
- Renew business licenses and permits
- Filing Articles of Amendment to notify the state of any significant changes to the business entity
Additional Tools and Resources
To simplify formation and compliance filing, CorpNet provides a variety of tools and resources:
- Business Name Search Tool – Check the availability of the business names you would like to use for their companies.
- Interactive Business Structure Wizard Tool – Answer a series of questions to obtain a sense of which business entity types might best suit your needs.
- Compliance Portal and Alert – This easy-to-use portal helps you keep track of your upcoming compliance requirements. You can set up proactive compliance alerts so you don’t miss upcoming deadlines.
We have a lot of additional articles to help you decide if an LLC is right for your business:
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