Learn more about the different ways to incorporate a business.
In the earlier parts of this series, we discussed the more traditional forms of business organization: partnerships, and corporations. But these are not your only options. In fact, the fastest growing category of small businesses are limited liability companies, a choice that's quickly becoming the most popular form for new businesses with more than one owner.
A limited liability company (LLC) is a hybrid entity that combines the advantageous tax aspects of a partnership with the limited liability protection of a corporation or a limited partnership. Unlike a partnership, the members of an LLC are not personally liable for the actions or debts of the business or of the other business owner(s).
What's more, unlike an S corporation, there are no limits on the number or types of members in an LLC, and much less in the way of corporate formalities that need to be followed to operate an LLC. There's no need to establish a board of directors, hold annual meetings and record the minutes, although the LLC will generally have an annual obligation to file documents and pay fees to the state of origination.
All states permit single-owner LLCs. However, for federal tax purposes a single-member LLC is taxed as a sole proprietorship. An LLC with more than one member is generally treated as a partnership for both federal and state income tax purposes. That is, there is no separate business income tax; the income or loss, deductions, credits, and other tax items are passed through to the members and taxed on their individual tax returns. (Some states, however, do impose a business income tax on LLCs as they do on corporations.)
However, IRS regulations permit business owners to elect whether they wish to be taxed as a partnership or as a corporation. If the business is not incorporated under state law, the IRS will presume that a non-publicly-traded, multiple-owner business should be taxed as a partnership, regardless of how many of the corporate characteristics it has.
To form an LLC, articles of organization must be filed with the secretary of state's office. Some jurisdictions also require that an operating agreement be filed. The articles of organization contain basic information about the LLC, such as its name, address, purpose, who organized it, who the registered agent is, etc.
The operating agreement for an LLC is similar to a partnership agreement. Its purpose is to guide the conduct of the business. If your state does not require the operating agreement to be filed with the articles of organization, it does not need to be written; however, as a precautionary measure, we recommend that the operating agreement be written and signed by all members. Moreover, it should be reviewed by your attorney to be sure that all the bases are covered and that potential conflicts among the members are minimized.
There are some disadvantages to LLCs. For one, the initial fees and ongoing annual fees to the state can be as high or higher than the fees charged to corporations. Also, the laws of the various states differ somewhat in their definitions and treatments of LLCs. As a result, if you will be operating your business in several states, transactions outside the state of formation by the LLC may be treated differently from transactions within the state of formation.