As a San Francisco business attorney I frequently advise San Francisco Bay Area companies on business formation issues. In previous blog posts, I discussed sole proprietorships, partnerships and corporations. This post covers California limited liability companies (LLCs).
Limited Liability Companies
A limited liability company is a business entity that provides flexibility to its members by requiring fewer formalities than a corporation, the benefit of limited liability protection to its members, and a flow through tax structure.
Operations and Management
In order to form an LLC, business owners first must file "articles of organization" with the California Secretary of State before conducting business. While a corporation must hold annual meetings and keep accurate corporate minutes, LLCs are not required to do so. In addition, LLCs do not issue stock, however LLCs do issue membership interests. LLC members must enter into a verbal or written operating agreement. Although not required, a written operating agreement is recommended in order to memorialize the terms of agreement between the members and to guide management of the business.
An LLC has no board of directors and similar to a general partnership, members of an LLC have the right to participate in management of the LLC, unless the LLC's articles of organization and operating agreement provide that the LLC is to be managed by a manager or managers. As you can see, the LLC operating structure is much more flexible than a corporation and often is considered an advantage.
Limited Liability Protection
Barring limited exceptions or a piercing of the company veil, like the shareholders of a corporation, members of the LLC have limited liability for the debts and obligations of the LLC. This means that member liability for the acts of the business is restricted to the amount of each members' capital investment.
An LLC offers flexible tax treatment as well. A single member LLC is taxed as a sole proprietorship. An LLC with more than one member will be taxed as a partnership. However, an LLC can elect to be taxed as a corporation. Members of an LLC that are taxed as a partnership can agree to share the profits and losses as they see fit and are not limited, as in the corporate structure, to a distribution of profits and losses based on a strict pro rata ownership percentage. The flow through tax structure of a partnership is often an attractive benefit for business owners and investors who elect to form an LLC.
As a "flow through" entity, an LLC does not pay federal income tax. California, however, does tax the LLC according to a gross receipts fee or $800, whichever is greater. In a high revenue business with low profits, the gross receipts tax may be higher than if the LLC elects to be taxed as an S corporation which has a 1.5% tax on corporate profits. Additionally, the S election also would eliminate the state self-employment tax, for which LLC members are typically responsible.
Furthermore, members of an LLC treated as a C corporation split profits and losses the same way that shareholders of a C corporation would. The LLC, electing tax treatment as a C corporation is subject to the greater of an 8.84 percent corporate state income tax rate or a minimum tax of $800 and in the event an S election is made, the LLC would be taxed at a rate of 1.5% of profits.
Due to the variety of factors involved in determining the optimal tax structure and the tax consequences, it is important to seek guidance from appropriate tax and legal advisers regarding your individual circumstances prior to finalizing the tax structure of an LLC or any entity choice.
State of California Franchise Tax Board, Limited Liability Company (LLC)
Selecting the Right Entity For Your Business and Considerations When Buying or Selling a Business
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