A Limited Liability Company is an excellent and flexible way to structure a small business, but because everyone’s business and personal situation is unique, it may or may not be the right structure for you. Here are five things you need to know before you start an LLC.
1. What is a Limited Liability Company?
A limited liability company (LLC) is a business entity designed to offer business owners who make a proper filing with the state:
- freedom from personal liability for the debts of the business;
- freedom from the debts of each partner
- the option to manage the business and receive tax advantages obtained through the use of partnership status;
- limited liability so that owners are not personally liable for business obligations; and
- flexibility for business growth and business succession.
The LLC can be member-managed or manager-managed. The LLC combines the best attributes of a corporation (protection and succession) and a partnership (tax benefits).
2. How do you form an LLC?
In Virginia, an LLC is formed by filing “Articles of Organization” with the State Corporation Commission. The Articles of Organization provide very basic information with respect to the name of the company, the agent for service of process, the company’s address, and whether it is manager or member operated.
3. How is an LLC Structured?
An LLC is structured much like a partnership, with the owners being referred to as members instead of partners. The LLC can be member-managed in a manner similar to a general partnership or it can be manager-managed like a limited partnership. If the LLC is member-managed all members will typically have an equal vote and collectively make all operational and management decisions. If the LLC is manager-managed, the members decide on major financial and business decisions and the manager handles the day-to-day business operations. An LLC may also be structured to provide estate tax discounts and succession planning in family businesses.
4. How is the structure of the LLC determined?
The founding members of the LLC determine the structure by means of an Operating Agreement which is similar to a partnership agreement. The Articles of Organization filed with the state are required to include the management structure and define whether the LLC is member-managed or manager-managed. The members will then have an experienced attorney draft an Operating Agreement which sets out the various rights and responsibilities of the members and covers matters such as capital contributions, division of profits, tax elections, management, member meetings, transferability of ownership interests, dissolution, and indemnification.
5. How does an LLC deal with accounting and taxes?
Recent changes in federal tax law (“check-the-box” regulations), have allowed LLCs to choose between taxation as a partnership and corporate taxation. In most instances it is better to be taxed as a partnership. When electing to be taxed as a partnership, the LLC files an informational tax return and issues K-1 statements to its members. The K-1 shows the member’s share of the income or loss incurred by the LLC, all of which flows through to each member’s personal tax return. If the LLC is taxed like a partnership or S Corporation, the LLC will not pay corporate income tax. If the LLC is a single member LLC, the owner may treat it as a disregarded entity for tax purposes and report the tax and related accounting on the individual tax return of the member. This eliminates the necessity of filing a tax return for the LLC.
Establishing an entity for your business requires that a number of management and tax issues be addressed. For that reason, you should always engage the services of an attorney who specializes in business and corporate law to determine the best solution for your unique situation.