Owners of limited liability corporations (LLCs) are called members, and they can be individuals or business entities, including other corporations. To effectively run your business, it’s a good idea to fully understand the various legal elements of ownership and the impact for all entities.
How LLCs Are Structured
An LLC is an increasingly popular business structure for startups, offering liability protection for ownership and greater flexibility than a corporation, particularly in terms of taxes. The LLC itself does not pay taxes. As a “pass-through” entity, income passes through the business to the owner or owners, who report it on their personal tax returns. An LLC is created by filing paperwork with your state, and nominal fees are involved.
LLC owners are called members, and ownership is defined either as a percentage or in units that represent a certain percentage. The percentage of ownership dictates how profits and losses are allocated to the members. The ownership percentage applies to all assets of the LLC.
Usually, the members have contributed capital to the company or have ownership for other contributions, such as the role they play in the company. The proportion of each member’s ownership is generally based on the amount of their contribution, but it can be proportioned in any way its members agree upon. All members get a share of profits based on their ownership percentage, as well as voting rights and other rights as defined in the operating agreement.
Members can be individuals, corporations, or other LLCs. An LLC must have at least one member, and the number of members it can have is unlimited. The exception to this is when an LLC chooses to be taxed as an S-Corp, its number of members is capped at 100.
Reasons a Corporation Would Be an LLC Member
Having a corporation as a member of the LLC offers an additional layer of ownership, for the owner of the corporation, who may also have increased personal liability protection. The main situation in which a corporation becomes an LLC member is when a holding company structured as a corporation chooses to have an LLC operating company to provide some of the benefits of an LLC.
Define the Ownership in the Operating Agreement
An operating agreement is not usually required but is highly recommended, particularly when a corporation is an LLC member. The operating agreement should clearly define the following:
- The percentage of each member’s interests in the LLC, including the corporation
- How profits and losses will be allocated to each member
- Each member’s rights and responsibilities
- The management structure and management roles of members
- The voting rights of each member
- Rules for meetings and voting
- What happens when a member sells their interest, becomes disabled, or dies
- What happens if the member corporation is dissolved
It’s a good idea to have an attorney’s help when creating your operating agreement so that you can be sure you’re covering all bases to protect all members, including the corporation, and avoid future issues.
Taxation of the Corporate Member
The pass-through taxation of the LLC applies to the member corporation. The appropriate share of the member corporation’s income passes through to the corporation and becomes the income of the corporation, subject to corporate taxes. The same would apply if the LLC has losses instead of profits.
Exceptions to Corporations as LLC Members
There are a few situations in which a corporation cannot be an LLC member.
If the corporation is a bank or insurance company, it cannot be a member because banks and insurance companies cannot be LLCs. In the case of a professional limited liability company (PLLC), a corporation cannot be a member because PLLC members must be professionals licensed with the state.
In most situations, corporations can be an LLC owner, or member. It’s most commonly done when a holding company owns an LLC operating company. Because such situations can be complex in terms of legal issues and taxation, it’s highly recommended that an attorney and tax advisor are involved in the LLC’s formation.