What is a Limited Liability Company?
A Limited Liability Company (“LLC”) is an entity which is taxed like a partnership but affords its owners, known as “members,” limited liability in the same manner as a corporation. Members can be individuals, corporations, or other LLCs and there is generally no minimum or maximum number of members. Like a corporation, LLCs are distinct legal entities which can sue, be sued, commit crimes, be victimized by crimes, hire, fire, give gifts, make decisions, and hold property in their own name. LLCs are created and governed by state law.
Although not as flexible as partnerships, LLCs are given significant flexibility to decide how the entity will conduct business and be managed by adopting “operating agreements.” Some types of businesses, for example banks and insurance companies, are prohibited from operating as LLCs.
How to Create a Limited Liability Company
Although the exact requirements vary from state to state, creating a Limited Liability Company is generally a four step process. These steps are:
- Filing of Articles of Organization: Articles of organization containing all of the required provisions must be filed with the secretary of state.
- Payment of a Filing Fee.
- Adopt Operating Agreements: Although not required by law, LLCs generally chose to adopt operating agreements which control the way the LLC is managed and organized. If an LLC elects not to adopt an operating agreement, state law provides a default set of rules to govern the management and organization of the LLC. Common provisions of operating agreements include: the percentage interest of each member, voting powers and procedures, how profits and losses are allocated, and transfer provisions (e.g. how a member can sell their interest and/or what happens if a member dies).
- Publish Notice: A few states require publication of notice of the intent to form an LLC.
Articles of Organization
Although requirements vary from state to state, articles of organization are usually required to have four elements:
- A statement that the entity being created is a Limited Liability Company
- Name: The name of the LLC, included an indication that the entity is a Limited Liability Company, which is generally accomplished by including the letters “LLC” after the corporation name. The name cannot be deceptively similar to any existing entity registered with the secretary of state. States also prohibit the name of LLCs from containing certain words which are considered misleading.
- Agent and Office: The street address of the LLC’s official (sometimes called “registered”) office and its registered agent. The registered agent is a person who can accept important documents on behalf of the LLC.
- Members: The name of all of the members of the LLC.
Consequences of Organizing as a Limited Liability Company
Tax Consequences
Because the federal tax code does not recognize “LLC” as a classification, LLCs must file tax returns as a corporation, a partnership, or a sole proprietorship. If the LLC has only one member, they can file as either a sole proprietorship or a corporation. If the LLC has 2 or more members, it can elect to file as a corporation or a partnership.
Members of LLCs ordinarily elect to be taxed in the same way as a partnership, meaning profits and losses “pass through” to the members of the LLC, rather than being taxed first as income to the corporation, then a second time as income to the member. Members are taxed on their share of the LLCs taxable income regardless of whether the profits are actually distributed or are retained by the LLC. Pass through income to members is generally subject to the so-called “self employment taxes.” LLCs can also be taxed in the same way as C-corporations if the entity affirmatively elects to be subject to corporate taxation rules by filing out IRS Form 8832. An entity which does not file Form 8832 is presumed not to have elected to file as a corporation and is thus taxed as a partnership or sole proprietorship depending on the number of members.
Liability Consequences
Members of an LLC are not personally liable for the debts and/or obligations of the LLC. This means a member’s liability is limited to the amount of money they contribute and any liability for personal bad acts.
Courts may “pierce the veil” of an LLC and hold members personally liable for the debts of the LLC in the same way courts pierce the veil of corporations, though establishing a “lack of corporate formalities” is more challenging because LLCs are required to observe fewer formalities.
Advantages of Operating as a Limited Liability Company
The major advantages of a Limited Liability Company are:
- Limited Liability for Members
- Partnership Taxation
- No maximum or minimum (usually) number of owners.
- Transferability of Ownership: As a general rule, shareholders can sell shares to any party at any time for any price. Unlike partnerships, a party’s ability to transfer his ownership and control interest to a third party is not limited.
- Flexible Structure: Through the use of operating agreements, LLCs can be tailored to fit the needs of the members by allowing for significant flexibility in the allocation of profits and the management of the entities affairs.
- Reduced Formalities: LLCs are subject to fewer formalities than corporations. Most notably, LLCs do not have to keep formal minutes or have formal meetings.
Disadvantages of Operating as a Limited Liability Company
The disadvantages of a Limited Liability Company are:
- Limited Life: LLCs dissolve upon the bankruptcy, death, or voluntary dissociation of a member (though some contingencies can be planned for via operating agreements).
- Formalities: Unlike sole proprietorships and partnerships, LLCs require paperwork to create and are subject to some formalities in order to retain limited liability status.
- Prohibited from Engaging in Certain Businesses: Many state prohibit LLCs from engaging in particular businesses, most commonly banking or insurance.
- State taxes and fees: In addition to an original filing fee, states charge renewal fees. Additionally, some states, most notably New York, levy a “franchise tax” on LLCs.
- Difficulty in Transferring Ownership: Unlike corporate stock, a member’s ownership interest in an LLC cannot be transferred without the consent of the other members (though their share of the profits is freely transferable).
Legal Disclaimer
This website provides information addressing legal topics of interest to the general reader. You should not consider this information designed or adequate to meet any of your particular legal needs, concerns or inquiries. You should consult with a lawyer licensed to practice law in the jurisdiction appropriate to your legal situation to assess your situation and provide you with appropriate legal advice. A good starting point for finding a lawyer is to contact your state’s bar association.
This article is copyrighted by Knowledge Website, LLC – 2010