LLC Introduction

What is an LLC?

An LLC, or Limited Liability Company, is a flexible business structure allowed by state statute. LLCs are known for combining the liability protection of a corporation with the simplicity and flexibility of a partnership. Essentially, as an owner (or member), you'll have protection from personal liability in most instances, meaning personal assets like your house or car won't be at risk if your LLC faces bankruptcy or lawsuits.'

Key Features of LLCs

• Liability Protection: Similar to corporations, LLCs provide their owners with limited liability for business debts and obligations.

• Flexible Taxation: Before electing to be taxed as an S Corporation, LLCs can be taxed like sole proprietorships (single-member LLCs) or partnerships (multi-member LLCs), where profits and losses pass through to owners' personal tax returns.

• Operational Flexibility: LLCs can set up their operating agreements to suit their business needs without the formalities corporations must adhere to, such as board meetings and minutes.

Why Choose an LLC-based S Corp?

Many businesses prefer an LLC structured as an S Corp for several reasons:

• Tax Benefits: Electing S Corp status allows the LLC to enjoy pass-through taxation, avoiding double taxation while allowing owners to be treated as employees for tax purposes. This can lead to significant payroll tax savings.

• Streamlined Management: LLCs can be member-managed or manager-managed, giving owners flexibility in how they want to run their business. In a member-managed LLC, all members participate in the business's daily management. In contrast, a manager-managed LLC appoints specific managers to handle these tasks, which can be beneficial for larger, multi-member LLCs.

The Complexities of Multi-Member LLCs

Operating a multi-member LLC can introduce additional complexities:

• Default Taxation: Multi-member LLCs are treated as partnerships by default, requiring specific forms and compliance measures, such as issuing K-1 forms to each member.

• Self-Employment Taxes: Members must pay self-employment taxes on their income from the LLC, similar to how partners in a partnership would.

• Management Structure: The need for structured management becomes crucial as more members join, which can either be a benefit or a challenge based on the LLC's specific needs.

LLC Management Structures

An LLC’s management structure can be either member-managed or manager-managed. Member management vests power in the members, while manager management vests day-to-day power in dedicated managers. The optimal structure depends on the LLC's specific circumstances.

Here are the main differences between member-managed and manager-managed LLCs.

Member-Managed LLC:

• Each member has equal rights in managing the company. There are no separate non-member managers.

• Management is handled directly by the members, similar to a partnership. Major decisions often require consent of a majority of members.

• Members have authority to act as agents of the LLC and bind it to contracts and debt in the ordinary course of business.

• Less common once there are multiple members, since it can become inefficient.

Manager-Managed LLC:

• The LLC has appointed non-member managers who handle the company's day-to-day operations.

• This management structure is more like a corporation, with managers in charge of running the business.

• Only managers can act as agents of the LLC and make decisions binding the LLC. Regular members have limited authority.

• More common for multi-member LLCs because it centralizes management decisions.

• Managers have fiduciary duties to the LLC and can be held liable for mismanagement.

• Members still vote on major decisions like electing managers, amending the operating agreement, or merging/dissolving the LLC.

Spouses in an LLC

Involving your spouse in the business can be done in two ways—either as an employee or a co-owner. Each has distinct implications for taxation, liability, and profit-sharing. Carefully consider what fits best for your personal and business circumstances.

Employee Spouse:

• The spouse is hired by the business owner and treated like any other employee. They have no ownership stake.

• The spouse must be paid a reasonable salary and wages for any work performed.

• Payroll taxes like FICA must be withheld and the spouse receives a W-2.

• The employed spouse may be eligible for certain employee benefits like health insurance.

• Business owners can deduct the compensation paid to the spouse as a business expense.

• Income earned by the spouse comes from their employment, not business ownership.

Co-Owner Spouse:

• The spouse has an ownership stake in the business, acquired either through investment or grant.

• The co-owner spouse shares in profits and losses on their ownership percentage.

• The spouse is not entitled to compensation and benefits as an employee. Any money withdrawn is owner distributions, not payroll.

• Payroll taxes are not paid on distributions to the co-owner spouse.

• Business profits pass through to the spouse's personal tax return based on ownership share.

• Co-ownership can complicate divorce if community property rules apply.

• May allow bigger tax benefits but less employee protections.

Please note that Collective services are currently limited to single-member LLCs. Some exceptions may exist for members located in community property states. Those states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.

Disclaimer: The information contained in this document is provided for informational purposes only and should not be construed as financial or tax advice. It is not intended to be a substitute for obtaining accounting or other financial advice from an appropriate financial adviser or for the purpose of avoiding U.S. Federal, state or local tax payments and penalties.