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The limited liability company (LLC) is a hybrid of a corporation and a limited partnership that is created under state law. For federal tax purposes, an LLC is treated identically to a partnership and it must file a Form 1065, U.S. Partnership Return of Income, unless the LLC files Form 8832, Entity Classification Election, and elects to be treated as a corporation. However, an LLC with only one member is not considered a separate entity, unless it elects to be taxed as a corporation. For federal tax purposes, the single-member LLC is the same as operating as a sole proprietorship.
Under state laws, LLC owners are given the protection from liability that was previously afforded only to corporate stockholders. Although the LLC is a relatively new business form, all of the states have now enacted legislation providing for limited liability companies.
However, the LLC's tax treatment for federal tax purposes is not always the same for state tax purposes. Your state department of revenue can tell you the rule in your state.
Comparison with S corporations. While S corporations also provide limited liability for their owners and favorable pass-through tax treatment, LLCs do provide some additional advantages to growing businesses. Like a partnership, an LLC has the ability to make disproportionate distributions to its owners (for example, a LLC member may have a 50 percent ownership interest in LLC assets but be entitled to 60 percent of the income, if the operating agreement so provides). In contrast, S corporations must generally make all distributions pro rata in accordance with the number of shares held by each owner. An LLC can have an unlimited number of investors, whereas an S corporation is limited to 100 shareholders.
Other factors to consider. There are a number of nontax factors that may influence your decision as to whether a LLC is the right form of business for you, and we recommend that you seek legal advice in setting up a LLC and writing up the operating agreement.