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What is an LLC?

What is an LLC?

A limited liability company (LLC) is a legal entity formed to operate a business. It provides many of the advantages of a traditional corporation, but it is easier to form and maintain.

There are fewer formal meetings and documentation than with a standard corporation.  All LLC owners are typically protected from personal liability for business debts and claims.  Normally, LLC owners stand to lose only the money that they’ve invested in the LLC.

Unlike a corporation, an LLC is typically what the IRS calls a “pass-through entity,” like a partnership. This means that business income passes through the business to the LLC owners, called members, who report their share of profits or losses on their individual income tax returns.

However, LLCs may choose to be taxed as a C corporation or as an S corporation by filing an election with the IRS. Most LLCs remain with the default form of taxation but electing to be taxed as an S corporation can have advantages.

In S corporations, the employment status of owners who work in the business differs from those of an LLC taxed under the default rules: The owner of an LLC taxed under the default rules is not an employee of the LLC for tax purposes, and the entire net earnings are passed along to the members in the form of self-employment income and are, therefore, subject to self-employment tax.

S corporation tax treatment can provide a way to take distributions from the LLC without paying employment taxes. A member of an LLC taxed as an S corporation does not have to pay employment tax on distributions (dividends) from the business. Historically, this has been a primary reason S corporations have been popular.

That said, an owner/employee of an LLC taxed as an S corporation must be compensated for his or her services with a reasonable salary and must report any company earnings on his or her personal income tax return and pay his or her share of payroll taxes on salary received. The business must also withhold federal income and employment tax from the owner/employee’s pay and pay state and federal unemployment taxes and Social Security and Medicare taxes on the employee’s behalf.

Additionally, an LLC taxed under the default rules offers more flexibility in how members can allocate the percentage of profits and losses among themselves, as the allocation does not need to directly correspond to the ownership percentages. By contrast, an S corporation does require the allocation of profits and losses to directly correspond to the ownership percentages.

As stated above, S corporation status is elected with the IRS. This involves filing IRS Form 2553. We will work with the tax advisor of your choice, or refer you to one, to discuss the preparation of all tax forms.

Still not quite sure what an LLC is? Please contact us at OWM Law with further questions, or to discuss your business planning needs and choice of corporate entity.

— Written by Joseph K. Koury, Esq.

DISCLAIMER: The contents of this blog are not legal advice, and are not to be used for that purpose.  If you are faced with a legal matter, you should contact a lawyer immediately in order to ensure that you are protected.


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