What is an LLC (from a legal perspective)?
LLC stands for Limited Liability Company, and over the past decade, has gained much popularity among new business owners…but what is an LLC? Is it right for your business?
As the name implies, an LLC is a business structure created by state law that provides limited liability protection from its owner(s), which are called members. An LLC may provide protection against the member’s personal assets. For example, if your LLC is sued (and you’ve maintained your LLC appropriately) your personal assets such as your home, automobiles, bank accounts may be protected. This layer of protection is often referred to as the “corporate veil”. Please note that because the LLC business structure is created by state law (as opposed to federal law), the protection afforded to the LLC will differ by state and consulting with a business attorney within your state is recommended.
A couple things to note regarding the paragraph above:
1. If someone sues you personally (not the LLC), and you have no personal assets, the plaintiff’s attorney may go after your LLC’s assets. In layman’s terms, an LLC can protect against someone suing your LLC and going after your personal assets but it does not provide protection against someone suing you personally and going after your business assets.
2. Your LLC needs to be maintained appropriately in order for it to receive liability protection. What does this mean? You should:
a. Maintain a separate bank account for your LLC (do not comingle LLC and personal funds).
b. Use your company name and logo on all contracts and marketing materials.
c. Hold annual meetings and record the discussions in meeting minutes (meeting minutes are a summary of what was discussed during the meeting).
d. Pay your state’s annual reporting / filing fees to keep the LLC in “active” status.
e. Draft and maintain an operating agreement for your LLC.
What is an LLC (from a Tax Perspective)?
An LLC, when utilizing the default tax treatment provided by the IRS, does not change the way you file your federal income tax return as a sole proprietor. Let me elaborate:
Single-Member LLCs: A single-member LLC is an LLC in which there is only one member (owner). By default, a single-member LLC is considered a “disregarded entity” for tax treatment purposes by the IRS. In other words, for tax purposes, the single-member LLC is taxed in the same exact manner as a sole proprietor.
How is a Sole Proprietor (and single-member LLC) taxed?
A Sole Proprietor will report all business income or losses on their personal tax return by completing Schedule C, Profit or Loss from a Business which will be submitted together with Form 1040, U.S. Individual Income Tax Return. In other words, a sole proprietor attaches an additional schedule to their personal tax return. (There is not a separate federal income tax return that needs to be filed with the IRS when your business is a single member LLC).
Multi-member LLCs: A multi-member LLC is an LLC in which there are two or more members. By default, a multi-member LLC is treated as a partnership for federal income tax purposes. As a result, the multi-member LLC will file Form 1065, U.S. Return of Partnership Income, a separate informational tax return. The LLC members will then be issued a form called a K-1 to report each LLC member’s share of the partnership’s earnings, losses, deductions and credits. The amounts on the K-1 will be used to prepare Form 1040, Individual Income Tax Return for each of the LLC members. To summarize, unlike single member LLCs, there is a separate tax return that must be prepared and filed with the IRS for multi-member LLCs.
For more information related to LLCs, visit the Learning Library at FileYourBusiness.com and review the LLC frequently asked questions. There you will find out what is an S Corporation and how an LLC can be treated as an S Corporation or C Corporation for tax purposes.
About the author: Navi Maraj is a Certified Public Accountant in the State of Florida and is the President of FileYourBusiness.com, Inc. FileYourBusiness.com is a website dedicated to educating entrepreneurs about legal entity types and their respective tax treatment. Additionally, Florida entrepreneurs can utilize FileYourBusiness.com to form their business.
Disclaimer: The content of this article is not to be considered legal or tax advice and is provided for informational purposes only.