Limited Liability Company - LLC

For More Limited Liability Company (LLC) Information please visit our entire website section on LLC's.

A limited liability company, or LLC is a business organization structure that allows for certain favorable tax treatments, as well as personal liability protection, for the “members” involved. It is important to note that the specific structure and status can vary from state to state so complete consideration to the state’s laws in which the LLC will be formed is crucial.

An LLC as a business structure model allows for multiple owners, or “Members,” and a “Managing Member,” to enjoy limited liability. The Managing Member is typically the figure head of the organization and is responsible for it’s management. The profits or losses of the business organization pass directly through to the Member's personal income tax return (IRS Form 1040). The LLC files a Form 1065, then lists each member's taxable profit on IRS Form K-1. The net profit of the LLC is not considered to be income earned by the Members (though it can be for the Managing Member as a special “fringe benefit” treatment--see below), and thus is not subject to self-employment tax.

Advantages of the LLC
An LLC allows for an unlimited number of Members; however, if the LLC has just one owner (Member), it will be taxed as a sole proprietorship.
The LLC allows for the "special allocation" of profits--the disproportionate splitting of Member profits and losses (in different percentages than their respective percentages of ownership). This means that Members can enjoy the benefits of receiving profits (and writing off losses) in excess of their individual ownership percentage.
The Members enjoy Limited Liability, which means they are mostly personally protected from any liability of the LLC and successful judgments, as well as from the LLC itself.
Managing Members' share of net profit is considered earned income because the Managing Member is considered to be an active owner--therefore qualifying the Managing Member for special "fringe benefit" treatment.
The Members' share of the bottom-line (“net”) profit of an LLC is not considered earned income, and therefore is not subject to self-employment tax.
Members are compensated using either distributions of profit or guaranteed payments. A distribution of profit allows each member to pay themselves by merely writing checks--whenever they need the money (provided the business has the available cash). Guaranteed payments represent earned income to the members, thereby qualifying them to enjoy the benefits of tax-favored “fringe benefits.”
The Managing Member of an LLC can deduct 100% of the health insurance premiums he or she pays, up to the extent of their pro-rata share of the LLC's net profit, because the profit is considered earned income. Note: If a member has earned income, he or she will also qualify.
A Corporation can be a member of an LLC. This allows you to create an additional level of ownership, which is designed to create an entity that can offer such traditional “fringe benefits” as retirement plans and an additional level of protection from liability.
As a Member, you can contribute capital or other assets to the LLC, or loan the LLC money to put dollars or value into the business. You can take dollars out by taking a repayment of your loan (plus interest), a distribution of profit or a guaranteed payment. If any of the members die, the LLC can continue to exist--subject to the unanimous positive vote on the part of all remaining members.
Disadvantages of an LLC
Each Member's pro-rata share of profits represents taxable income--whether or not a member's share of profits is distributed to him or her.
The Managing Member's share of the bottom-line profit of the LLC is considered earned income, and therefore is subject to self-employment tax.
The Members' share of bottom-line profit is not considered earned income because the Members are considered to be inactive owners; therefore, the Members do not qualify for special tax-favored "fringe benefit" treatment.
As a member of an LLC, you are not allowed to pay yourself wages.
Additionally, the LLC shares a few benefits over other business structures--for example, while a Sub-chapter “S” corporation may allow for many of the same protections and asset distribution facilities, they are limited to 75 “stockholders,” and none of these stockholders can be in the form of a Corporation nor IRA’s (in direct contrast to an LLC which does permit Corporations as “Members”)--thus limiting this option to smaller organizations or forcing the buyback or buyout of stockholders for those organizations wishing to convert.