An LLC, or limited liability company, is a business structure allowed by state statute, and each state may use different regulations (IRS, Limited liability company (LLC)). Its owners are called members, and nothing about being an LLC decides how it is taxed.
Those are two separate questions, and holding them apart is most of the work. State law creates the entity and supplies the liability shield. Federal tax law then classifies it, and the classification is chosen rather than inherited.
What State Law Makes
The form is a hybrid by design. A limited liability company is a non-incorporated business organization that retains elements of both partnerships and corporations, and the form allows a lot of flexibility in arranging the organization to the specific needs of its investors (Cornell LII, Wex, limited liability company (LLC))). An LLC can be composed of members that each own and control equal parts of the business, or it can be managed by some members with different control and profit allocations among all the members.
The ownership rules are unusually open. Most states do not restrict ownership, so members may include individuals, corporations, other LLCs and foreign entities, there is no maximum number of members, and most states also permit single-member LLCs, those having only one owner (IRS, Limited liability company (LLC)).
There are exclusions, and they are set by the state rather than federally. A few types of businesses generally cannot be LLCs, such as banks and insurance companies, and there are special rules for foreign LLCs (IRS, Limited liability company (LLC)).
The Shield, and the Way Out of It
The liability rule is state law, so it is stated here from one state’s act rather than as a national rule. Delaware’s is representative and is the one most often litigated.
Except as otherwise provided by that chapter, the debts, obligations and liabilities of a limited liability company, whether arising in contract, tort or otherwise, shall be solely the debts, obligations and liabilities of the limited liability company, and no member or manager shall be obligated personally for any such debt, obligation or liability solely by reason of being a member or acting as a manager of the limited liability company (6 Del. C. section 18-303(a)).
Two qualifiers in that sentence do the real work. Except as otherwise provided by this chapter means the shield is not absolute even within the act. Solely by reason of being a member or acting as a manager means it protects the status, not the person’s own conduct.
The section then has a second subsection that most summaries drop, and it is the one that explains a personal guarantee. Notwithstanding the provisions of subsection (a), under a limited liability company agreement or under another agreement, a member or manager may agree to be obligated personally for any or all of the debts, obligations and liabilities of the limited liability company (6 Del. C. section 18-303(b)). A member who signs a guarantee has contracted out of the shield, and the statute expressly permits it.
Federal Tax Treatment Is a Separate Question
Depending on elections made by the LLC and the number of members, the IRS will treat an LLC as either a corporation, partnership, or as part of the LLC’s owner’s tax return, a disregarded entity (IRS, Limited liability company (LLC)).
The defaults run on member count. A domestic LLC with at least two members is classified as a partnership for federal income tax purposes unless it files Form 8832 and affirmatively elects to be treated as a corporation, and for income tax purposes an LLC with only one member is treated as an entity disregarded as separate from its owner, unless it files Form 8832 and elects to be treated as a corporation (IRS, Limited liability company (LLC)).
The regulations behind those defaults are the check-the-box rules at 26 CFR 301.7701-2 and 26 CFR 301.7701-3, and they are set out in corporation, while where the resulting treatment sits among the flow-through forms is covered in pass-through entities. What an S election adds on top is in S corporation.
The Election Has a Filing Window
This is the part that is easy to miss and hard to fix afterwards. An LLC that does not want to accept its default federal tax classification, or that wishes to change its classification, uses Form 8832, Entity Classification Election, and generally an election specifying an LLC’s classification cannot take effect more than 75 days prior to the date the election is filed, nor can it take effect later than 12 months after the date the election is filed (IRS, Limited liability company (LLC)).
The IRS notes that an LLC may be eligible for late election relief in certain circumstances (IRS, Limited liability company (LLC)). That is relief, not a right, so the window is the thing to work to.
Disregarded for Income Tax Is Not Disregarded for Everything
The word disregarded is narrower than it sounds, and the carve-out is stated on the same page as the rule. For purposes of employment tax and certain excise taxes, an LLC with only one member is still considered a separate entity (IRS, Limited liability company (LLC)).
So a single-member LLC with employees is its own entity for payroll purposes while its operating results land on the owner’s return.
Common Questions
Not by being called one. An LLC is a non-incorporated business organization (Cornell LII, Wex, limited liability company (LLC))), and it becomes a corporation for federal tax purposes only by election (IRS, Limited liability company (LLC)). The classification regulations that decide it are worked through in corporation.
By default, as a partnership with two or more members and as a disregarded entity with one, unless Form 8832 is filed to elect corporate treatment (IRS, Limited liability company (LLC)). An LLC can receive pass-through taxation like partnerships or may choose corporate taxation should it be preferred (Cornell LII, Wex, limited liability company (LLC))).
No, and the statute says so twice over. Delaware’s shield applies except as otherwise provided by its own chapter and only solely by reason of being a member or acting as a manager, and the following subsection lets a member agree to be obligated personally by agreement (6 Del. C. section 18-303). Other states have their own acts, so the operative text is the one for the state of formation.
Different starting points under state law. An LLP is a general partnership that registered with its state, a route set out in limited liability partnership, while an LLC is formed as an LLC from the outset under a state’s limited liability company act.
At the point where a client says “we set up an LLC” and the preparer has to find out what that means for the file. The answer needs the state of formation, the member count, whether any classification election was filed and when, and whether the entity has employees. None of those is on a bank statement, and the first return prepared on an assumption sets a treatment that is awkward to move afterwards.
Accountably places trained offshore accountants and tax preparers inside US CPA and EA firms, and a firm can run a real block of its own entity return preparation and review work through a trial task before anything client facing depends on it.
