LLCs: Hybrid Structure May Offer Best of Both Worlds

A limited liability company (LLC) provides many of the legal advantages of a corporation but can choose to be taxed as a partnership or a sole proprietorship. An LLC establishes a separate entity to help shield the business owners’ personal assets from lawsuits brought against the firm by its customers or employees.

In theory, the financial exposure of the owners (members) is limited to their stake in the company, but exceptions may include any business debt they personally guarantee or misdeeds (such as fraud) they carry out. Unlike a limited partnership, an LLC typically permits all of the members to participate in management of the business without compromising their liability protection.

Here are a few more distinctions between LLCs and other common business structures.

Relative Simplicity

An LLC is generally easier and less expensive to create and maintain than a corporation, and there may be fewer compliance requirements associated with operating an LLC. The management structure is less formal, so a board of directors and annual meetings are not usually required.

Even so, an LLC generally requires more effort than a partnership. You must file articles or a certificate of organization (a document that outlines the company’s purpose and structure and provides contact information) with your state and create an operating agreement in which you prescribe, among other things, how the LLC will operate and the relationship between members.

Tax Matters

When an LLC is taxed as a partnership, the company’s income, losses, and other tax attributes pass through to the owners in accordance with the operating agreement. Members report their distributive share on their personal tax returns.

Members of an LLC may agree to allocate profits and losses among themselves in any way they wish, unlike an S corporation, which requires distribution of profits in proportion to ownership interest. This freedom may be useful when some owners are actively involved in day-to-day activities and others are not. Otherwise, an LLC may elect to be taxed as an S or a C corporation, provided that it qualifies for the particular tax treatment.

An LLC may be a good option for family businesses that want to keep control in the family, as well as companies with a small number of active investors. It is also well suited for real estate investments or joint ventures between existing businesses.

The specific rules and requirements for LLCs are complex and vary by state. Be sure to consult your legal and tax professionals before taking any specific action.

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