If you’re considering forming a limited liability company (LLC), you might have some questions, including about whether an LLC has shares. The answer is no, an LLC can have neither shares nor shareholders, because, unlike a corporation, it cannot issue stock.
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 that the members agree upon. All members get a share of profits based on their ownership percentage, as well as voting rights and other rights that are 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.
How Corporations Are Structured
A corporation is a legal business entity that is separate from its owners. Corporations, like individuals, can enter into contracts, pay taxes, hire employees, be involved in legal action, loan or borrow money, and own assets. Corporations offer personal liability protection for their shareholders, and shareholders benefit from the profits of the corporation.
A corporation is created when it is incorporated by a single shareholder or group of shareholders who have ownership of the corporation in the form of common stock. A corporation can be for-profit or non-profit. Shareholders pay money for the common stock but have no further financial responsibilities to the company.
A corporation must have a board of directors, which is responsible for implementing and executing the company’s business plan. The board of directors is elected by the shareholders. A corporation pays taxes on its profits, and shareholders pay taxes on their dividends, which is sometimes referred to as “double taxation.”
LLCs are unique in terms of taxation as their owners have a choice about how it will be taxed. By default, an LLC is taxed like a sole proprietorship if it has one member and a partnership if it has more than one member.
In both cases, business income passes through the company to the members, who report profits and losses on their individual tax returns. The LLC itself is not taxed, which simplifies the process for members. Also, losses and operating costs of the business can be deducted personally by the members. Taxes are paid at the personal tax rate of the members, although the owners may also have to pay self-employment taxes.
Note that a multi-member LLC must also file form 1065 with the IRS, which is the U.S. Return of Partnership Income. Attached to this will be form K-1s for each member showing their share of the business income.
But LLCs owners can instead choose to be taxed as a corporation. To do so, the LLC must file a document, referred to as an election, with the IRS. The LLC must then decide if it wishes to be taxed as an S corporation or a C corporation.
C Corp status means profits are taxed at the current rate for corporations (21% as of early 2022), which is significantly lower than the typical individual taxpayer rate. But keep in mind, C Corp shareholders, which includes members, must also pay taxes on their distributions (but not self-employment taxes). Thus, the C Corp is subject to what is sometimes referred to as double taxation.
As with sole proprietorship and partnership status, S Corp taxation considers the LLC a pass-through entity, which means income passes through the company and into the hands of the owners. At this point, taxes are applied at the same rate as those of individual taxpayers.
S Corps use Form 1120S to file their taxes, which is used to report the income, losses, and dividends of S corporation shareholders. S Corp shareholders do not pay self-employment taxes, which is the primary advantage of S Corp status compared to sole proprietorship or partnership.
NOTE: LLCs that choose to be taxed as corporations can still NOT issue shares. The corporation election applies to taxation only.
Why Do Shares Matter?
If you’re in a high-growth industry and plan to raise money from investors, a corporation may be your best option in the long run. Investors can give you capital in exchange for shares, which is a fairly simple process. Often, investors will not invest in LLCs simply because of the fact that they cannot issue shares.
If you have an LLC, however, and you want to raise capital, you can dissolve your LLC and form a corporation at any point.
To sum up, an LLC does not and cannot have shares. The ownership of members is usually expressed as a percentage. The main negative impact of this is the potential difficulty raising capital. If you need to know more about which business structure to choose, or if you’re considering changing your LLC to a corporation, it’s recommended that you speak with an attorney and tax advisor. It’s a crucial decision that can affect the future of your company.