How Does Ownership in an LLC Work?

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The LLC, or limited liability company, is a flexible form of company organization that allows owners to be treated as partners, yet be taxed as corporate shareholders if the company so chooses. As an LLC owner, your rights and responsibilities are determined by the operating agreement that governs the LLC.

Members

  • LLC owners are known as "members." LLCs typically operate like a partnership, with members sharing profits and losses in proportion to their investment in the LLC. Although most states do not require LLCs to execute operating agreements, most are governed by operating agreements that spell out each member's ownership interest -- the proportion of profits and losses shared by each member. LLCs are not required to distribute ownership interests in direct proportion to each member's investment in the LLC. Nevertheless, unless an operating agreement states otherwise, most states apply legal "fallback provisions" that grant ownership interests in direct proportion to each member's investment.

Management

  • LLCs may be managed by the members, by non-member employees or by a management committee composed of some of the members. Some LLC members do not want to take an active role in managing LLC affairs, preferring instead to treat their ownership interests as passive investments. In many cases, LLC members are granted ownership interests in proportions greater than their investments in the LLC, in exchange for providing management services.

Voting

  • Many LLCs distribute voting rights in proportion to ownership interests -- the vote of a member with a 10 percent interest in the LLC will count twice as much as the vote of a member with a 5 percent interest, for example. Other LLCs grant each member one vote, regardless of ownership interest. Still others allow only managers to vote. State fallback provisions apply if no operating agreement exists, or if the operating agreement is silent on the issue of voting rights. These fallback provisions differ from state to state.

Transferability

  • Members may sell, assign, gift or bequeath their ownership interests in the LLC. In many states, a majority of members must consent before such transfer is allowed. In other states, LLCs may spell out the terms of transfer of interests in the operating agreement. In most states, members may assign the right to profits and losses yet retain voting rights, as long as this is not forbidden by the operating agreement.

Taxation

  • An LLC is taxed as a partnership unless it elects to be taxed otherwise. It may be taxed as a "C" corporation or, if it qualifies, as an "S" corporation. LLC members will be taxed accordingly. In partnership taxation scheme, each member is taxed on all LLC profits in proportion to his ownership interest.

References

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