Limited Liability Company
First recognized in Wyoming, formed by members, Limited Liability Companies or LLCs are only recognized at a state level and disregarded by IRS. This means, that LLCs may be subject to state taxation but do not pay federal taxes or file any returns. Does this exempt an LLC member from federal taxes? No. Indeed, IRS automatically defaults single member LLCs to sole proprietorships and multi member LLCs to general partnerships and sets exactly the same tax filing and paying requirements. For instance, an LLC organized by 3 members in 2023, will have to file general partnership form 1065 by March 15 2024. The main purpose for forming an LLC is to limit the liability of members, just like the name suggests. The LLC cannot issue shares but instead has a membership that is proportional to the member’s contribution. There is generally no limit on the number of members. If one or more of the members manage the LLC it is called a member managed LLC. If a non-member manager is hired it is called a manager managed LLC.
Taxation
As mentioned, LLCs are taxed based on their classification. By default, single-member LLCs are classified as sole proprietorships and multi member LLCs as general partnerships. Therefore, they pay the same taxes and file the same forms on a federal level as sole props and general partnerships. On the state level, there may be additional forms and tax requirements that will be covered in our states section.
Registration
To Register an LLC, follow these steps:
File articles of organization with your state. Articles of organization outlines the key information about the LLC and is made public. The information includes but is not limited to: The name of the LLC; principal and mailing address; Registered agent; number of members; Most states will require updating articles of organization by filing annual or biennial reports even if no changes were made. In our states section we’ll cover the requirements for each state.
Prepare an operating agreement: while not mandatory, an operating agreement outlines how the LLC will be managed; how the key decisions will be made; appoints managers; defines what will happen after passing of a member;
Obtain an EIN number: Unless it is a single member LLC without employees an EIN is required.
Collect membership contributions: members will make initial deposits.
Start operations.
LLC as a corporation
The members of an LLC can make an election to be taxed as c or s corporation by filing respectively forms 8832 and 2553. Once the election is approved by IRS, the LLC will have exactly the same tax filing and paying responsibilities as a corporation. The main reason someone would want to have an LLC taxed as a corporation instead of directly opening a corporation is the vast liability protections the LLC offers. While corporation owners and officers are typically not personally responsible for the liabilities of the corporation, due to certain loopholes it may be possible to pierce through the corporate protections and go after the owners and officers on individual level. On the other hands LLCs provide much stronger protections.
Paying yourself
Members cannot be employed or contracted by the LLC and instead should take distributions from the net income. 100% of the net income must be distributed. Just like in case of general partnerships, it is up to LLC to allocate the distribution between members. Each member will pay a personal income tax or corporate income tax if the member is a corporation based their part of distribution. There is no special procedure required for a distribution. A simple bank transfer or writing a check to a member will suffice. The same logic applies when making contributions to the LLC. However, if the LLC made an election to be taxed as a corporation, the corporate compensation rules will apply.