Just How Flexible Is A Limited Liability Company?
The business entity form that is the limited liability company (“LLC”) is known for being flexible, but just how flexible is it? An LLC’s flexibility is twofold. First, there is great flexibility in tailoring the governance structure of an LLC to the needs and preferences of its constituent members. Second, there are multiple ways in which the members of an LLC may choose to have it taxed that is also based on their needs and preferences.
LLC Governance
Generally, LLC statutes are composed largely of default rules; most LLCs have a written agreement tailoring the rules to the specific needs and preferences of the LLC’s members and managers—called an “operating agreement” (Delaware calls it a “limited liability company agreement”). The typical operating agreement addresses, among other things, management structure, allocation of profits and losses among the members, member taxation, transfer of membership interests, and dissolution. An LLC can either be member-managed or manager-managed. Most LLC statutes’ default rule is to have the LLC be member-managed, unless it is specifically stated that the LLC is manager-managed in articles of organization filed with the state in which the LLC is based. Member management is similar to a partnership in that management of the LLC is decentralized. Manager management is similar to a corporation in that management of the LLC is centralized.
Taxation of an LLC
The Internal Revenue Service treats LLCs with at least two members as a partnership under Subchapter K for tax purposes by default. A single member LLC is treated as a disregarded entity by default for tax purposes—in other words, the entity is disregarded for tax purposes and the sole owner is taxed as an individual. However, members of an LLC may elect on Form 8832 to be taxed as a corporation under Subchapter C. Furthermore, if the LLC’s members choose to be taxed as a corporation, they may further elect on Internal Revenue Service Form 2553 to be taxed as an S corporation—also known as a small business corporation. Finally, it is possible to later change the tax status of an LLC, but the tax consequences may be severe depending on what tax status the LLC currently holds and to which tax status the LLC members intend to convert it. As always, it is of the utmost importance to consult your tax and legal advisors before making such a decision in order that all of the benefits and detriments can be weighed.
Jared M. Groth is an associate attorney at Lippitt O’Keefe, PLLC in Birmingham, MI. Jared assists his partners in advising clients in a wide variety of industries on business matters including general corporate counseling, mergers and acquisitions, start-up counseling, venture capital, corporate finance, technology licensing, and a variety of contract law matters.