Limited liability company (LLC)
A state-law shield with no federal tax category of its own: disregarded, a partnership, or a corporation by election.
A limited liability company is a state-law entity: you file formation papers with a state, and the members are shielded from its debts the way shareholders are. For federal tax it has no category of its own. It takes whichever classification it qualifies for by default or chooses: a disregarded entity with one member, a partnership with two or more, or a corporation if it elects one.
Its books look like a partnership's. Instead of common stock and retained earnings, each member has a capital account. Here is Northwind's first entry if the founders had formed an LLC: the same $60,000, credited to two members' capital accounts instead of common stock.
Members contribute capital
| Account | Debit | Credit |
|---|---|---|
| 1000Cash — operating | 60,000.00 | |
| 3010Member capital — founder A | 30,000.00 | |
| 3020Member capital — founder B | 30,000.00 | |
| Balanced | 60,000.00 | 60,000.00 |
If Northwind were an LLC: the founders' contribution.
Single-member LLC (disregarded)
- Good at
- Liability shield with the owner's own return.
- No separate federal income tax return.
- Watch for
- Self-employment tax on all of the profit.
- Some states tax the LLC itself — California's $800 a year.
- Best for
- A solo business that wants a liability shield and no corporate return.
Multi-member LLC (partnership)
- Good at
- One layer of tax.
- Flexible allocations written in the operating agreement.
- Losses pass through to the members.
- Watch for
- Every member gets a K-1, and their own return waits on it.
- Can't grant incentive stock options or issue QSBS.
- A venture fund investing in one meets the tax problems the Delaware C corporation lesson describes.
- Best for
- Co-owned services firms, real estate, holding companies.
Where this lesson's rules come from
The sources behind this lesson's requirements, by kind. Background reading explains; it is never the authority for a rule. Anything marked as a convention is ours, not the rule-maker's.
- Federal regulation
- Treas. Reg. §301.7701-3(b)(1) (opens in a new tab)Default classification of a domestic eligible entity — the check-the-box rulesFree to read
- Treas. Reg. §301.7701-2(b)(1), (c)(2)(iv) (opens in a new tab)Incorporated entities are corporations per se; a disregarded entity is still the employer for employment taxesFree to read
- IRS guidance
- IRS, Limited liability company (LLC) (opens in a new tab)How the IRS classifies an LLCFree to read
- Federal agency guidance
- SBA, Choose a business structure (opens in a new tab)Choose a business structure — the SBA's overview of the optionsFree to read
- Background reading — not an authority
- Wikipedia, “Limited liability company” (opens in a new tab)Limited liability companyFree to read
The words this page teaches
Each links to its glossary definition, which also names the authority behind it and the components that render it.
- Limited liability companyA state-law entity whose owners (members) are shielded from its debts like shareholders. Federal tax has no LLC category: by default it is a partnership with two or more members and disregarded with one, and it is a C or S corporation only if it elects
- Disregarded entityAn eligible entity with one owner that has not elected to be a corporation, ignored for income tax so its results go on the owner's return — Schedule C for an individual owner. It is still a separate legal entity, and still the employer for employment taxes
- Check-the-box electionThe election on Form 8832 by which an eligible entity — an LLC or a partnership, never a corporation formed under a state's corporation statute — chooses its federal tax classification. Effective no more than 75 days before or 12 months after it is filed, and after a change, no second change for 60 months