Limited Liability Company

A limited liability company (denoted by L.L.C. or LLC) in the law of many of the United States is a legal form of business company offering limited liability to its owners. It is similar to a corporation, and is often a more flexible form of ownership, especially suitable for smaller companies with a limited number of owners. Unlike a regular corporation, a limited liability company with one member may be treated as a disregarded entity, so the member is often singled-out as a person performing the actions of the LLC. A limited liability company with multiple members may choose, generally at the time that the new entity applies for a US federal taxpayer ID number, to be treated for U.S. federal taxation purposes as a partnership, as a C corporation, or as an S corporation. An LLC can elect to be either "member managed" or "manager managed."

Management Structure

Choosing to operate by member management creates a flat member or partnership structure. Choosing manager management creates a two-tiered management structure potentially convertible into a corporation, with the attendant tax consequences. LLCs use IRS Form 1065 (if taxed as a partnership) and Schedule SE (Self-Employment Tax). It is often incorrectly called a "limited liability corporation" (instead of company). LLCs are organized with a document called the "articles of organization", or "the rules of organization" specified publicly by the state; additionally, it is common to have an "operating agreement" privately specified by the members. The operating agreement is a contract among the members of an LLC governing the membership, management, operation and distribution of income of the company.

Managing members are the individuals who are responsible for the maintenance, administration and management of the affairs of a LLC. In most states, the managers serve a particular term and report to and serve at the discretion of the members. Specific duties of the managers may be detailed in the articles of organization or the operating agreement of the LLC. In some states, the members of an LLC may also serve as the managers.

Members are the owner(s) of a LLC. Unless the articles of organization or operating agreement provide otherwise, management of an LLC is vested in the members in proportion to their ownership interest in the company.

Operating as an LLC form of partnership does not mean that appropriate US federal partnership tax forms are not necessary, or not complex. As a partnership, the entity's income and deductions attributed to each member are reported on that owner's tax return.

LLCs can lose their tax advantage without the partnership structure. The possible label "disregarded entity" for income tax purposes singles out the one-member owner of an LLC as actually earning income and deductions directly. It is the owner, then, who reports as a business proprietor, rather than as an LLC operating an active trade or business. An LLC passively investing in real estate and owned by a single member would have its income and deductions reported directly on the owner's individual tax return on a Schedule E tax form. And an LLC owned by a corporation--in other words, an LLC with a single corporate member--would be treated as an incorporated branch and have its income and deductions reported on the corporate tax return, creating double taxation.

Advantages

There are numerous advantages of choosing an LLC over an S-Corporation or other form of business entity.  Some of these include:

1. No requirement of an annual general meeting for shareholders.
2. No loss of power to a board of directors.
3. Much less administrative paperwork and recordkeeping than a corporation.
4. Pass-through taxation (i.e., no double taxation), unless the LLC elects to be taxed as a corporation.
5. Limited liability, meaning that the owners of the LLC, called "members," are protected from liability for acts and debts of the LLC.
6. Using default tax classification, profits are taxed personally at the member level, not at the LLC level.
7. Check-the-box taxation. An LLC can elect to be taxed as a sole proprietor, partnership, S corporation or C corporation, providing much flexibility.
8. LLCs in some states can be set up with just one natural person involved.
9. Membership interests of LLCs can be assigned, and the economic benefits of those interests can be separated and assigned, providing the assignee with the economic benefits of distributions of profits/losses (like a partnership), without transferring the title to the membership interest.
10. LLCs in most states are treated as entities separate from their members, whereas in other jurisdictions case law has developed deciding LLCs are not considered to have separate juridical standing from their members.
11. Unless the LLC has chosen to be taxed as a corporation, income of the LLC generally retains its character, for instance as capital gains or as foreign sourced income, in the hands of the members.

Disadvantages

In spite of the many aforementioned advantages of limited liability companies over other business entities, there are some potential disadvantages, including:

1. Many states, including Alabama, California, Kentucky, New Jersey, New York, Pennsylvania, Tennessee, and Texas, levy a franchise tax or capital values tax on LLCs. (Beginning in 2007, Texas has replaced its franchise tax with a "margin tax".) In essence, this franchise or business privilege tax is the "fee" the LLC pays the state for the benefit of limited liability. The franchise tax can be an amount based on revenue, an amount based on profits, or an amount based on the number of owners or the amount of capital employed in the state, or some combination of those factors, or simply a flat fee, as in Delaware. Effective in Texas for 2007 the franchise tax is replaced with the Texas Business Margin Tax. This is paid as: tax payable = revenues minus some expenses with an apportionment factor. In most states, however, the fee is nominal and only a handful charge a tax comparable to the tax imposed on corporations.
2. It may be more difficult to raise capital for an LLC, as investors may be more comfortable investing funds in the better-understood corporate form with a view toward an eventual IPO. One possible solution may be to form a new corporation and merge into it, dissolving the LLC and converting over to a corporation.
3. The LLC form of organization is still relatively new, and as such, some states do not fully treat LLCs in the same manner as corporations for liability purposes, instead treating them more as a disregarded entity, meaning an individual operating a business as an LLC may in such a case be treated as operating it as a sole proprietorship, or a group operating as an LLC may be treated as a general partnership, which defeats the purpose of establishing an LLC in the first place, to have limited liability (a sole proprietor has unlimited liability for the business; in the case of a partnership, the partners have joint and several liability, meaning any and all of the partners can be held liable for the business' debts no matter how small their investment or percentage of ownership is).
4. Although there is no public requirement for an operating agreement, members who operate without one may run into problems.
5. Some people, such as new business people, may not be familiar with the governance of LLCs. Unlike corporations, they are not required to have a board of directors or officers.
6. The principals of LLCs use many different titles -- e.g., member, manager, managing member, managing director, chief executive officer, president, partner. As such, it can be difficult to determine who actually has the authority to enter into a contract on the LLC's behalf.

Articles of Organization

The Articles of Organization is a document similar to the articles of incorporation, outlining the primary rules governing a limited liability company. It is a necessary document for setting up a LLC in many U.S. states.

Operating Agreement

An operating agreement is an agreement among limited liability company ("LLC") members governing the LLC's business, and Member's financial and management rights and duties. No state requires an LLC to have an Operating agreement. LLCs operating without an operating agreement are governed by the State's default rules contained in the relevant statute and developed through state court decisions. An operating agreement is similar in function to corporate by-laws. In single member LLCs, an operating agreement is a declaration of the structure that the member has chosen for the company and sometimes used to prove in court that the LLC structure is separate from that of the individual owner and thus necessary so that the owner has documentation to prove that he or she is indeed separate from the entity itself.

An operating agreement is used to override default rules imposed by a state's LLC Act. Operating Agreements generally address: (i) member's capital and service contributions; (ii) management of the LLC (Member-Managed or Manager-Managed); (iii) buy-out provisions; (iv) voting rights; (v) managers' rights and responsibilities; (vi) distributions; (vii) tax planning; (viii) dissociation and dissolution.

Series LLC

A Series LLC is a special form of a Limited liability company that provides extra protection for personal assets comprised of multiple business entities.  Many form an LLC in order to protect personal assets from a legal claim relating to their real estate investment or business liabilities.  Additional liability protection may be gained by properly forming and maintaining a separate LLC to hold each property or business entity. By forming a separate LLC to own and hold each legally titled separate property or business entity, theoretically only the assets owned by a specific LLC would be subject to claims or lawsuits arising against that LLC. However there are costs and administrative burdens associated with properly forming, qualifying and maintaining each separate LLC. Another option may be to form a Series LLC, a.k.a. the "cell" LLC, if permitted under applicable laws. Although each cell of a Series LLC can own distinct assets, incur separate liabilities, and have different managers and members, a Series LLC pays one filing fee and files one income tax return each year, if each series member is also a founding member of the LLC. When non-founding members are added to a newly created cell within the Series LLC, that new cell should file a separate partnership tax return for that cell. Furthermore, liability incurred by one unit does not cross over and jeopardize assets titled in other subsidiary units of the same Series LLC.  Also, if a business owns real estate used in its operations, a Series LLC may avoid sales tax due on rent paid by the operating series to the real estate series. A Series LLC has been described as a master LLC that has separate divisions, which is similar to an S corporation with Q-subs.

The series LLC is not more widely used as a liability segregation technique because its tax treatment has not been fully resolved and because its effectiveness has not been tested judicially. Currently, the federal tax standards for a Series LLC with multiple members remains unclear. Some speculate that single entity federal tax treatment will require highly correlated assets, members and managers (particularly the last two). There is further speculation that California will only tax income from those series conducting business in California. Other states may follow.   However, as of April 2006, The California Franchise Tax Board has determined that each Series of a Delaware Series LLC must report and pay taxes as a separate entity in California.  Also, since the asset protection and planning advantages of the Series LLC have not been thoroughly challenged in asset protection cases, they remain theoretical, and unproven.

<< Previous   1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 | 11   Next >>