Limited Liability Company Basics 101
What is a Limited Liability Company?
- A Limited Liability Company, an “LLC,” is a distinct business entity that combines the powers held by a corporation and a partnership.
- While the individuals comprising a partnership are called “partners,” those entities comprising an LLC are known as “members;” a partnership, corporation, or another LLC, etc., can be a member, as most state statutes concerning LLCs do not restrict membership.
- Unlike a partnership, an LLC has the option to have only one member, should the member so choose (“single-member LLC”).
- Almost any business can qualify as an LLC (exception for “professional partnerships,” i.e., law firms, doctor’s offices, etc.).
- Most LLC owners participate equally in management (“member management”). Alternative is manager-management, where managers are selected and remaining members “back” the LLC.
The Advantages of an LLC
- An LLC retains the option to avoid paying taxes directly. Rather each member will report the LLC’s income and losses on their personal tax return (“pass-through” taxation).
- However, an LLC can decide in what manner to be taxed (i.e., an LLC can be taxed like a corporation, partnership, or sole proprietorship should it so choose). How the LLC is taxed will be dependent on the type of tax form filed; can claim deductions on taxes.
- Limited personal liability is the primary advantage to an LLC business structure; members are not legally liable on the LLC’s debts; if the LLC is sold or becomes bankrupt, a creditor cannot pursue a member’s personal assets.
- a. Exceptions: If a member personally or directly harms someone, gives a personal guarantee on a bank loan or business loan and the LLC goes into default, the member engages in fraudulent or illegal activity, acts in a manner that shows that the LLC is an extension of the member rather than a separate entity, etc.
- b. Steps to avoid personal liability: Provide adequate funding for the LLC, keep LLC and personal matters separate, create an operating agreement.
The Disadvantages of an LLC
- Like a partnership, an LLC can result in dissolution should a member die (depending on your state’s LLC regulations); a corporation’s existence can be perpetual. Therefore an operating agreement is crucial (can include buy-sell agreements).
- Overall, not many disadvantages. Disadvantages of an LLC are mostly associated with the exceptions to personal liability.
LLC v. Corporations
- An LLC is owned by its members, where corporations are owned by shareholders.
- LLC is easier to maintain overall and doesn’t require the extensive reporting requirements that a corporation does. For corporations, meetings are required to maintain corporation “status.” Can sell stock to raise capital.
- LLC has an overall advantage when it comes to taxes, maintenance, and limited liability.
What is required to Create an LLC?
- 1. Something like a “partnership agreement” is required to create an LLC, known as the “Articles of Organization.” The Articles of Organization need to be documented with the State to create a valid LLC.
- a. Steps in creating an LLC: picking a name, creating Articles of Organization or Certification of Organization/Certificate of Formation, creating an operating agreement, applying for a federal tax ID number, file an annual report, file with the Secretary of State, pay the filing fee ($100-800).
- b. Articles of Organization need to include the name of the LLC, contact information of someone associated with the LLC (“registered agent” who can be served with legal documents), possibly names and addresses of LLC members.
- 2. The Operating Agreement should establish the members rights, responsibilities, duties, powers, interest percentages, how income is split, etc.