The legal landscape of business structures often confuses new entrepreneurs regarding ownership terminology. A Limited Liability Company (LLC) and a Corporation are distinct entities, yet the terms used for their owners are often incorrectly interchanged. Understanding the correct terminology reflects fundamental differences in legal structure, documentation, and operational flexibility. This distinction governs how the business is formed, managed, and taxed by the Internal Revenue Service (IRS).
Members Versus Shareholders
An LLC does not have shareholders; its owners are legally referred to as members. This difference reflects a fundamental distinction in the legal relationship between the owner and the business entity. A corporate shareholder owns “shares” or “stock,” representing a specific unit of ownership that is often easily transferable and standardized. The shareholder’s role is typically passive, limited to voting on major corporate matters and electing the board of directors.
In contrast, an LLC member holds a “membership interest,” which grants rights to the company’s profits and losses, and often includes the authority to participate in management decisions. This interest is not typically represented by stock certificates, emphasizing the contractual nature of the LLC structure. The owner’s rights and responsibilities are primarily dictated by an internal agreement, not by strict corporate statutes.
Documenting LLC Ownership
The official instrument for formalizing and recording LLC ownership is the Operating Agreement, a private, contractual document among the members. This agreement outlines the exact ownership percentages, referred to as membership interests, which may not align directly with each member’s initial capital contribution. Unlike the corporate model, where stock certificates serve as proof of ownership, the Operating Agreement is the primary source of truth for an LLC.
The document details how profits and losses will be distributed, how capital accounts are maintained, and the procedures for admitting new members or transferring an interest. While some LLCs may optionally issue a membership certificate, this document only references the interest defined within the Operating Agreement. Since the agreement is internal and not filed with the state, it provides a high degree of privacy and customization for the owners.
Taxation Implications of LLC Membership
The LLC member structure provides significant tax flexibility, making it popular among small businesses. By default, the IRS treats an LLC as a pass-through entity, meaning the business itself does not pay federal income tax. Instead, profits and losses pass through to the owners, who report them on their individual tax returns.
A single-member LLC is taxed as a disregarded entity using the owner’s Schedule C. A multi-member LLC is taxed as a partnership, filing Form 1065 and issuing Schedule K-1s to its owners. This default status allows members to avoid the double taxation inherent in a standard C-Corporation.
LLC members have the option to elect corporate taxation by filing the appropriate forms with the IRS, such as Form 8832 for C-Corporation status or Form 2553 for S-Corporation status. Electing S-Corp status allows members to be treated as employees for a portion of their compensation, potentially reducing self-employment taxes on distributions. This tax election affects only how the business is taxed and does not change the owners’ legal status as members.
Management Structures for LLCs
The member structure grants flexibility in how the entity is governed, offering two primary management models. A Member-Managed LLC is the default structure in most states, where all owners actively participate in day-to-day operations and decision-making. In this model, every member generally has the authority to bind the company to contracts and agreements. This structure is often preferred by smaller LLCs with a limited number of owners who wish to be involved in daily affairs.
The alternative is a Manager-Managed LLC, where the members appoint one or more individuals to handle the daily operations. These managers may or may not be members themselves. Under this model, non-manager members take on a more passive, investor-like role, limiting their decision-making authority to major structural changes like mergers or dissolution. This separation of ownership and control is advantageous for LLCs with a large number of members or those delegating operational responsibilities to professional managers.