This guide is an overview of the Limited Liability Company (LLC) business entity that can be formed in the state of California and provides a general summary of ownership, management, tax, and liability considerations.
A limited liability company (LLC) is an independent entity that combines the personal liability protection of a corporation with the pass-through taxation and flexible structure of a partnership. An LLC provides greater versatility when dividing business responsibilities, liabilities, and assets.
An LLC can be formed to conduct business or to hold assets.
Best Suited For
LLCs may be a good fit for companies exposed to significant risk or investors with substantial personal assets to protect from liability. Startups often choose LLCs because they are intended to make starting a small business more accessible.
Some businesses such as banks, insurance companies, and certain professional service firms generally cannot be formed as LLCs.
Ownership & Control
An LLC is owned by its members, which can include individuals, corporations, other LLCs, and foreign entities. There is no legal limit to the number of members; however, a restriction can be placed in the company's Articles of Organization or Operating Agreement.
California permits LLCs with only one owner, called a "single-member LLC."
Members of an LLC become owners according to the terms of the Articles of Organization rather than stock ownership or option grants. The agreement lists the membership interest of each member and determines their rights and responsibilities. Members can be continuously added, removed, or replaced.
Member rights cannot be transferred to a third party, although a non-member may purchase the financial interest of a member. However, such a purchase does not grant them authority to control the business.
The share of ownership usually corresponds to the investment made into the company. Business profits and losses are divided among members, but the distribution may not correspond to ownership share. For example, a member with 10% ownership may collect half of the profits and bear no losses if this is agreed upon in the Articles of Organization.
Management & Operations
An LLC with two or more members should establish an Operating Agreement that describes its handling of operations, outlines the arrangements made between the members, and lays out dispute resolution processes.
Depending on the structure laid out in the Operating Agreement, an LLC can be managed by members or designated managers. If managed by members, at least one must be appointed as a "managing member" to oversee the daily business operations.
Stocks & Capital
A limited liability company cannot issue stocks. Instead, an LLC has "membership interest" or "membership units" that give members the right to participate in the business and determine the share of earnings and assets they are entitled to.
The Operating Agreement may further outline member interests as voting and non-voting units. This distinction is similar to how corporations authorize voting and non-voting stock.
Investors should be vigilant when funding LLCs because they can be challenging to divest from, are not regulated by the SEC, and do not afford the same protections and disclosure requirements as publicly traded corporations.
An LLC offers liability protection similar to a corporation, meaning that members are protected from personal responsibility against judgments or bankruptcy. The members' personal assets, both tangible and financial, are shielded from personal liability, and members cannot be held liable for the wrongful actions of others.
A limited liability company's taxation depends on how it elects to be classified by the IRS and the state's tax authority. It can be taxed the same as a sole proprietorship if there is one owner ("disregarded entity"), as a partnership if there are multiple members, or as a corporation if it chooses to do so.
An LLC must elect the same tax classification for both California and federal tax purposes.
An LLC passes through all business profits and losses to its members, who report their shares of earnings on a personal tax return. The company does not incur income tax; however, it is still subject to certain types of taxes, such as:
- payroll tax on salaries paid to employees
- property taxes on business-owned property
- sales tax on goods purchased by the company
LLC members are considered self-employed and pay self-employment tax contributions to Social Security and Medicare.
Forming a California LLC is done by filing an Articles of Organization (Form LLC–1) with the California Secretary of State.
An Operating Agreement outlining the business structure, organization, and rules of conduct is also required.
The Operating Agreement is not filed with the Secretary of State; the company maintains it at its headquarters.
LLCs cannot be formed to provide certain services that require a professional state license - these firms can consider other business entity types. The California Department of Consumer Affairs' Boards and Bureaus site offers more information on such professional services.
- IRS Limited Liability Company guide
- Small Business Administration (SBA) Limited Liability Company information
- California Franchise Tax Board (FTB) Limited Liability Company overview and Publication 1123 summary
- California Secretary of State (SOS) Limited Liability Company information