Limited Liability Company
A limited liability company, or LLC, is a business entity created under state law whose owners are called members. It generally separates the company’s legal obligations from the members’ personal assets while allowing flexible ownership, management, and federal tax treatment.
“She formed a limited liability company, became its sole member, and began signing client contracts in the LLC’s name rather than in her personal name.”
What Is a Limited Liability Company?
A limited liability companyLLCLLC stands for limited liability company, a business entity formed under state law whose owners are called members and who generally are not personally liable for the company's debts solely because they own...View definition , usually abbreviated LLC, is a business entity created under state law. Its owners are called members, and the structure generally separates the company’s legal obligations from the personal assets of its members.
The IRS describes an LLC as a business structure allowed by state statute and notes that the rules can differ from state to state. The IRS also explains that LLC owners are called members and that federal tax classification depends on the number of members and any elections the LLC makes. See the IRS overview of limited liability companies.
What Does “Limited Liability” Mean?
The phrase limited liabilityCorporation DefinitionA corporation is a legal entity created under state law that is separate from its owners, usually called shareholders. It can own property, enter contracts, incur debts, sue or be sued, and operate...View definition refers to the legal separation between the LLC and its members. As a general rule, a member is not personally responsible for an LLC’s debts merely because that person owns part or all of the company.
For example, if an LLC signs an ordinary vendor contract and later owes money under that contract, the creditor generally looks to the LLC and its assets rather than automatically treating every member’s personal assets as available to satisfy the debt.
That protection has limits. A member may still be personally responsible for obligations they personally guarantee, their own wrongful conduct, certain taxes or statutory obligations, or other circumstances recognized by applicable law. Courts may also disregard an entity’s separate status in unusual cases when the legal requirements for doing so are met.
Who Owns an LLC?
The owners of an LLC are called members. An LLC may have one member or multiple members, depending on state law and the company’s ownership structure.
- Single-member LLC: An LLC with one owner.
- Multi-member LLC: An LLC with two or more owners.
Members may be individuals or, where permitted, other entities. Their ownership percentages, voting rights, economic rights, management powers, and responsibilities are often described in an operating agreement.
How Is an LLC Formed?
An LLC is formed under state law by filing the required formation document with the appropriate state office and satisfying any other formation requirements.
The filing may be called articles of organization, a certificate of formation, or another state-specific name. It commonly identifies the LLC, its registered agentArticles of IncorporationArticles of incorporation are the formation document filed with a state to create a corporation. They typically provide basic information such as the corporation’s name, registered agent, share structure, and incorporator, although requirements...View definition , and other information required by the state.
After formation, an LLC may also need to obtain an Employer Identification Number, adopt an operating agreement, register for taxes or licenses, file annual or periodic reports, and satisfy other state or local requirements.
What Is an LLC Operating Agreement?
An operating agreement is the internal agreement that commonly explains how an LLC will be owned, managed, and operated. Depending on the company and state law, it may address:
- Ownership percentages and capital contributions
- Voting rights
- Profit and loss allocations
- Distributions
- Management authority
- Adding or removing members
- Transfers of membership interests
- Buyouts, death, disability, or withdrawal
- Dissolution and winding up
The operating agreement is different from the formation document filed with the state. The state filing creates or registers the entity, while the operating agreement primarily governs the relationship among the members and the operation of the company.
Member-Managed vs. Manager-Managed LLC
LLCs can use different management structures. In a member-managed LLC, the members participate directly in management. In a manager-managed LLC, management authority is given to one or more managers, who may or may not also be members.
Which structure applies depends on state law and the LLC’s governing documents. This flexibility is one reason LLCs are commonly used by closely held businesses.
How Is an LLC Taxed?
An LLC is a state-law entity, but LLC is not itself a single federal income tax classification.
The IRS explains that, depending on the number of members and any elections made, an LLC may be treated for federal income tax purposes as a disregarded entity, a partnership, or a corporation. A single-member domestic LLC is generally disregarded for federal income tax purposes unless it elects corporate treatment, while a domestic LLC with two or more members is generally treated as a partnership unless it elects to be treated as a corporation.
This distinction matters because an LLC can remain an LLC under state law even if it elects to be taxed as a corporation for federal tax purposes.
LLC vs. Corporation
An LLC and a corporation can both provide a separate legal structure and limited liability, but they are not the same entity type.
| Limited Liability Company | Corporation |
|---|---|
| Owners are called members | Owners are called shareholders or stockholders |
| Ownership is usually described as membership interests | Ownership is represented by shares of stock |
| May be member-managed or manager-managed | Typically uses directors and officers |
| Usually governed internally by an operating agreement | Usually governed internally by bylaws and corporate resolutions |
| Federal tax treatment can vary based on default rules and elections | Generally taxed as a corporation unless an eligible S corporation election applies |
LLC vs. Sole Proprietorship
A sole proprietorship is not a separate state-law entity from its individual owner. An LLC, by contrast, is created under state law as a distinct business entity.
A single-member LLC may be disregarded for federal income tax purposes, but that tax classification does not mean the LLC disappears as a state-law entity. The legal and tax concepts should be kept separate.
Limited Liability Company Example
Suppose a freelance designer wants to operate through a separate business entity. The designer files the state’s required LLC formation document, becomes the sole member, opens a business bank account, and signs client agreements in the LLC’s name. The LLC is the business entity, while the designer owns the LLC as its member.
The simplest way to understand the term is this: a limited liability company is a flexible state-law business structure whose owners are called members and that generally creates legal separation between the company’s obligations and the members’ personal assets.