If you’re considering starting a limited liability company (LLC), you may, depending on your state, have to disclose your LLC management structure when you file your LLC formation documents. It’s important to understand the different types of management structure before you decide which is right for your business.
In this comprehensive guide, you’ll learn about your management structure options and other details about managing an LLC.
LLCs are a common choice for new entrepreneurs, particularly because of the personal liability protection they offer. Member is a formal name for an LLC owner, and an LLC and its members are legally regarded as separate entities, so members are not personally responsible for the financial obligations of the business.
LLCs, however, are not taxed as a separate entity. The profits of the LLC instead pass through to the members who report the income on their personal tax returns on Schedule C. Taxes owed are based on the members’ personal tax rates, although members must also pay self-employment taxes which fund Social Security and Medicare.
Member Managed LLC
A member-managed LLC is one in which all members have a management role in the company, and no key managers are non-members. Members can be given specific management functions, or they can simply co-manage all the functions of the business. Member-managed LLCs are common for LLCs that have only a few members or just a sole member.
Member roles are defined in an operating agreement, which also specifies ownership percentages, rules for profit allocations and distributions, and the voting rights of members on key decisions. It also defines how member disputes are resolved.
Manager Managed LLC
An LLC can also be manager managed. In a manager-managed LLC, there can be essentially three scenarios.
- One or more members are appointed as managers, while the remaining members are silent partners.
- One or more members are appointed as managers, other members are silent partners, and one or more non-members are also appointed as managers.
- All members are silent, and non-member managers are appointed to run the company.
The first option is most common and can occur when a member or members are simply investors in the company and have no management role.
A manager-managed structure also works better for LLCs that have a large number of members and having all of them involved in management is simply not feasible.
In any case, this management structure should be defined in the operating agreement.
The Role of LLC Managers
Managers, whether they are members or non-members, have a say in the day-to-day operations of the company. They also may have certain powers, which should be defined in the operating agreement. Such powers may include:
- Signing certain legal documents
- Managing and accessing bank accounts for the business
- Entering into contracts for the business
- Obtaining financing from lenders or investors
- Hiring employees
Members who are not managers generally lose some of this control. This is why the management structure decision for your LLC is so important.
LLC Management Flexibility
Other than choosing a member-managed or manager-managed structure, there are essentially no other requirements regarding the management of the LLC. Unlike a corporation, an LLC does not have to appoint officers or elect a board of directors. Managers of the LLC have full control and the flexibility to manage the business in any way that they choose. There are no annual meeting requirements, or corporate bylaw requirements.
LLCs are also much easier for members to form than a corporation.
LLC Electing S-Corp Status
LLC members have the additional benefit of being able to choose an S-Corp tax status for the LLC, which can provide self-employment tax savings. However, with the S-Corp election, the LLC then becomes subject to corporate requirements. Officers must be appointed and a board of directors, which must include some non-members, must be elected. The board of directors will then have oversight of key management decisions.
The management of the LLC is thus much less flexible. However, often LLC members may make the election because of the previously mentioned self-employment tax savings.
Let’s look at how S-Corp status works.
S-Corp status can be elected by filing form 2553 with the IRS. The LLC must meet certain requirements as defined by the IRS to qualify for S-Corp status. S-Corp status still offers pass through taxation for members, who are now called shareholders; however, S-Corp managers must take a reasonable salary, as defined by the IRS, before taking any distributions. That salary is subject to normal payroll taxes, which include taxes to fund Social Security and Medicare, but their distributions are not subject to self-employment taxes.
That self-employment tax savings is generally why S-Corp status is elected.
However, the corporation requirements and salary payments come with additional administrative and payroll costs. This means that S-Corp status only provides a financial advantage when the self-employment tax savings are greater than the additional expenses.
This election is best made with the advice of a tax advisor.
Note that a company set up as a C-Corporation may also elect S-Corp status if it qualifies.
When a C-Corporation May Be a Better Choice Than an LLC
When you set up a corporation instead of an LLC, you’re giving up management flexibility. A corporation is also a taxable entity and shareholder dividends are also taxed, which is referred to as double taxation. These factors are why many new business owners turn to an LLC.
However, the ownership of an LLC is much more difficult to transfer than that of a corporation. The ownership of a corporation is measured in shares rather than percentages, and those shares can be transferred or sold. This makes corporations much more attractive to investors since they can simply offer a certain amount of investment capital in exchange for a number of shares.
So, if you plan to raise venture capital at some point, a corporation may be a better choice than an LLC.
One of the main advantages of an LLC is the management flexibility it offers. You only have to choose a member-managed or manager-managed structure. When you’re forming an LLC, however, it’s often best to have an attorney involved who can advise you on key decisions and draw up your operating agreement. They can ensure that your business gets off to a good start and has the best chance of becoming a thriving company.