What is a Limited Liability Company?

Written by JGPC Business Law on January 6, 2012.

Updated October, 2026.

Editor’s note: This blog post represents historical legal commentary. This article was originally published in 2012 and discusses the structure, taxation, and operation of limited liability companies under the laws in effect at that time. California’s Revised Uniform Limited Liability Company Act took effect on January 1, 2014, replacing the previous statutory framework.

Limited liability companies offer business owners considerable flexibility in structuring their operations, ownership interests, and tax treatment. This article examines the legal nature of LLCs, their different federal tax classifications, and the role of operating agreements in establishing economic and management rights. It also discusses how variations in state LLC laws can affect the structure and operation of these entities.

Key Takeaways

An LLC is a separate legal entity formed under state law.
LLC members generally receive protection from personal liability for the company’s debts and obligations.
LLCs combine characteristics commonly associated with corporations and partnerships.
Depending on ownership and applicable elections, LLCs may be taxed as disregarded entities, partnerships, S corporations, or C corporations.
An LLC’s federal tax classification does not change its underlying status as an LLC under state law.
Operating agreements establish important rules governing ownership, management, voting rights, and economic interests.
California law allows flexibility in structuring LLCs, subject to statutory requirements and limitations.
LLC laws differ among states, making the jurisdiction of formation an important consideration.
Business owners should evaluate legal, operational, and tax consequences before selecting an LLC structure.

Many business transaction lawyers spend much of their professional lives creating, structuring, and manipulating the “unnatural persons” of the legal world, those entities identified as “persons” under the law that are not “natural persons”. These “unnatural persons” are the building blocks of modern civilization. They are the conceptual entities, or “legal entities,” that we natural persons use to organize our lives and to bring continuity, stability, and structure to our lives and societies in our effort to cope with the endless changes of the natural world. We might think of these legal entities as bridges we, as natural persons, build over the endless flow of the river of time. These entities help us bring order to the natural world, what we normally think of as “reality”, and enable us natural persons to organize ourselves in productive ways.

Some “unnatural persons” recognized in our laws today have arisen organically out of human experience. Such prehistoric unnatural persons familiar to western and other cultures might include such entities as marriages, families, partnerships, tribes, villages, kingdoms, and other ancient political and social groupings. Other familiar “unnatural persons” are largely products of modern human conceptual creativity, and are “conceptual tools” created by societies and their governments through written laws, constitutions, case law and legal codes to help solve social problems, promote social organization or provide some social advantage to a group of people. Nations, states, counties, cities, school districts, corporations, trusts, and limited liability companies are just a few examples of such modern conceptual legal entities or “unnatural persons” that natural persons have intentionally created to provide some beneficial organizational structure for our societies.

For business transactions attorneys, the modern limited liability company is an interesting unnatural person with unique characteristics. The most significant characteristic of the limited liability company, sometimes identified as an “LLC”, is that the LLC has evolved into the “stem cell” of modern business entities. Under current California and federal law, the LLC can be structured to substitute for nearly all of the traditional business entities that we business transactional lawyers create in our daily practice. In many fact situations, some form of the LLC is the best choice of entity to promote a client’s goals. But many lawyers are not aware of the full range of flexibility of the LLC, and if we are aware of the many uses for this tool, we often seem to struggle when describing to each other the type of LLC that we are discussing.

Perhaps the lack of appreciation of the many LLC forms available to us and the confusion and difficulty in discussing these LLC forms is, in part, caused by a lack of a standardized, conceptual nomenclature for describing the different LLC forms available. It may be productive to develop such a standardized conceptual framework for classifying and describing the LLC variations.

The LLC is an unnatural person with a partnership heritage that is created by statue, structured by contract, and taxed by choice. This definition might not seem confusing on its face, but let’s explore it in a little more detail. The reasons for the LLC conceptual confusion will soon become apparent.

LLCs are taxed by choice. The conceptual framework for describing what form of LLC we are discussing became more complex with the decision to initiate the “Check the Box” rules for assigning the tax status to various entities. The “Check the Box” regulations allow the owners (“members”) of an LLC to chose a tax status they desire for the LLC by “checking a box” on an IRS form. In some fact situations the owners of an LLC may have the option to have their LLC taxed as: 1) a non-entity, 2) a partnership, 3) an “S” corporation, or 4) a “C” corporation. This tax classification does not change the identity of the LLC under state law; it just allows the owners to choose the LLC’s federal tax status. Most states, including California, require the LLC to use the federal tax status for state taxation. The LLC owners can also just as easily change the tax status of the LLC by submitting simple prescribed forms to the IRS. Though the change in tax status might have serious tax and other implications for a specific LLC, the procedure itself to change the tax status of an LLC is quite simple.

The possibility of LLC conceptual confusion now starts to become apparent because we now have 1) LLCs that are disregarded for tax purposes, 2) LLCs that are taxed as partnerships, 3) LLCs that are taxed as “S” corporations, and 4) LLCs that are taxed as “C” corporations. These are major variations for LLCs, and, in fact, are four different kinds of entities for tax purposes, entities that would have very different applications and uses. The significance of these LLC taxation alternatives is really equivalent to the use of a different entity, such as a sole proprietorship, a partnership, an “S” corporation or a “C corporation. The failure of practitioners to specify the tax status of an LLC as an integral part of the description of a specific LLC sometimes causes confusion, and such confusion may become more important as practitioners increasingly choose to use a tax status for LLCs other than partnership tax status, the historical default status.

One of the goals of this tongue-in-cheek essay is to urge lawyers to be sensitive to the LLC tax status issue and to clarify when necessary the tax status of an LLC under discussion. Is the lawyer talking about a “disregarded” LLC (perhaps we could call it a “DLLC”), a partnership LLC (a “PLLC”), an “S” corporation LLC (an “SLLC”) or a “C” corporation LLC (a “CLLC”)? Or perhaps there is a different nomenclature that Practitioners can agree upon to identify the tax status of an LLC?.

LLCs are structured by contract. The ownership structure and the manner in which a California LLC is operated and managed, what we call the “non-economic” interests, and the capital structure of an LLC, what we call the “economic interests” (that includes both capital and profits interests) are governed by a contract (the “operating agreement”) between the members of the LLC. Under California law, the parties can structure the LLC to operate as they wish with very few statutory provisions that cannot be changed in a written operating agreement. This statutory flexibility allows the creator of the LLC to draft an operating agreement that will create an LLC with a capital structure and an operational structure that looks just like that of a sole proprietorship, a limited partnership, a general partnership, an “S” corporation, a “C” corporation or some combination of any of the above. The creator can mix and match capital structures and operating structures in umpteen different ways. For example, an LLC can have a capital structure that is identical to that of a limited partnership, but have the operational structure of a “C” corporation, or vice versa.

With this structural flexibility, the opportunity for LLC conceptual confusion just became exponential. Now we have the possibility of an LLC that looks and functions like a sole proprietorship, a general partnership, a limited partnership, an “S” corporation, a “C” corporation, or any combination of these entities, but which in fact might be taxed as any other of these entities. What the practitioner means when he says “LLC” becomes somewhat unclear.

Perhaps lawyers can agree on a uniform nomenclature that more accurately identifies the form of an LLC. For example, building off of the suggested nomenclature for tax status offered above, perhaps creators can agree to add a descriptive phrase after the tax status identification described above to identify the capital and operating structure of the specific LLC under discussion. For example, an LLC structured to function as an estate planning entity for asset freeze, discounted asset transfers and asset protection purposes might be described as “a PLLC with an LP (limited partnership) capital structure and a P (general partnership) operating structure”. Now isn’t that crystal clear?

Additional LLC conceptual confusion is created by the fact that the LLC is a statutory creation and many state statutes are in conflict with one another. All of the states, including California, offer a statutory framework providing for the creation of an entity called the limited liability company. One complication here is caused by the differences between some of the state versions of the LLC. As yet, there is no uniform limited liability company act followed by the majority of states, and there are really significant differences between the structures and operations of various state versions of the LLC. A good example is the Delaware series LLC that many other states, such as California, do not yet offer and have not yet fully integrated with their own statutory version of the LLC. However, the conceptual clarification on this issue is simple; the practitioner just needs to indicate the state under which the LLC is formed. For example, if we were using a California LLC for our estate planning entity described above, we would identify it as “a CA PLLC with an LP capital structure and a P operating structure.” Now if we could all just agree on the nomenclature, working with LLCs would be simple.

Editor’s note: This blog post represents historical legal commentary. The article was originally published in 2013 and references California LLC laws in effect at that time. California’s Revised Uniform Limited Liability Company Act took effect on January 1, 2014, replacing the previous statutory framework.

Frequently Asked Questions

What is a limited liability company?

A limited liability company is a business entity formed under state law that generally provides its owners, known as members, with protection from personal liability for business debts and obligations. LLCs also offer flexibility in how they are managed and taxed.

How is an LLC different from a corporation?

Both LLCs and corporations generally provide limited liability protection to their owners. However, LLCs typically offer greater flexibility in management arrangements and may qualify for different federal tax classifications. Corporations have a different legal and governance structure.

How is an LLC taxed?

For federal income tax purposes, a single-member LLC is generally treated as a disregarded entity, while a multi-member LLC is generally treated as a partnership, unless an applicable corporate tax election is made. Eligible LLCs may elect taxation as an S corporation or C corporation.

What is an LLC operating agreement?

An operating agreement is a document that establishes rules for the LLC’s internal affairs, including management responsibilities, ownership interests, voting rights, distributions, and other matters affecting the members. California requires LLCs to maintain an operating agreement.

Can an LLC have different classes of ownership interests?

Yes. Subject to applicable law, an LLC operating agreement can establish different economic, voting, and management rights among members. This flexibility can help accommodate different investment arrangements and business objectives.

Can an LLC change its tax classification?

In some circumstances, an LLC may elect a different federal tax classification by satisfying applicable IRS requirements. These elections can have significant tax consequences and may be subject to timing and eligibility restrictions.

The content presented in this article is for general informational purposes only. It is not, nor is it intended to be, legal advice. It does not constitute the formation of an attorney-client relationship. Contacting us does not create an attorney-client relationship. Please do not send any confidential information to us until such time as an attorney-client relationship has been established.

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