A limited liability company (denoted by L.L.C. or LLC in the US) is a legal form of business company offering limited liability to its owners.

October 10, 2006 — Leave a comment
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A limited liability company (denoted by L.L.C. or LLC in the US) 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 restricted numbers of owners. It is often incorrectly called a “limited liability corporation,” (instead of company). In fact, an LLC is more a status than it is an entity, as it can be taxed like a partnership or corporation, depending on how its members, partners, or shareholders file its first taxes.

United Kingdom and Ireland

In the United Kingdom and Ireland, a limited liability company is called a private limited company by shares and is designated as “Limited” or “Ltd.” Formerly, all limited companies, both public corporations and private limited liability companies, were designated as Limited; now, public companies are designated as public limited company (plc) and private companies as Limited. However, limited liability companies are taxed at corporate rates, and dividends to shareholders are further taxed.

In 2002, the UK legislated limited liability partnerships (“LLPs”) into existence, which more closely proximate LLC’s in the USA. Member partners are taxed at the partner level, yet the LLP provides limited liability from LLP liabilities for the member partners.

United States

The limited liability company form was introduced relatively recently to the United States, with a statute having been first considered (but not adopted) in Alaska in 1975 and the first statute adopted in Wyoming in 1978. An LLC provides limited liability to owners of its equity interest, similar to a corporation and certain limited liability partnerships, and in contrast to the personal liability for the debts and obligations of the business that are borne in the general partnership, joint venture or sole proprietorship. A variant of the LLC available in some jurisdictions, typically limited to licensed professionals such as lawyers, physicians, or engineers, is the professional limited liability company (denoted by “P.L.L.C.” or “PLLC”). In most cases the PLLC is identical to a non-professional LLC except that there are additional rules related to professional regulation; the scope of those rules varies state to state. Although some people refer to an LLC as a “limited liability corporation”, the correct terminology is “limited liability company”. All states permit an LLC to be organized with a single member.

Basically, an LLC allows for the flexibility of a sole proprietorship or partnership structure within the framework of limited liability, such as that granted to corporations. A perceived advantage of an LLC over a corporation or limited partnership is that the formalities required for creating and registering LLCs are much simpler than the requirements most states place on forming and operating corporations or limited partnerships. Two examples of simplified requirements are: the lack of requirement for annual meetings of shareholders (LLCs have “members”) and no requirement for written bylaws (LLCs have an operating agreement or regulations, but there is no requirement that they be in writing). As contrasted with a limited partnership, which require that the general partners be named in the certificate of limited partnership, LLC acts do not require that the articles of organization list the members or the managers. Most LLCs will, however, choose to adopt an Operating Agreement or Limited Liability Company Agreement to provide for the governance of the Company, and such Agreement is generally more complex than a corporation’s bylaws. Note, too, that some states, such as New York, require an operating agreement.

For purposes of U.S. tax law, a curious feature of the LLC is that an LLC can elect how it should be treated for federal and often for state income tax purposes. An LLC with one owner, for example, is treated as a sole proprietorship by default (when an LLC has a single owner – either an individual or an entity – it is a disregarded entity for federal tax purposes), but this one owner LLC can also elect to be treated as a C corporation or as an S corporation. Further, an LLC with more than one owner is treated as a partnership by default, but a multiple owner LLC can also elect to be treated as a C corporation or as an S corporation. To elect C corporation treatment, an LLC files a Form 8832 ([1]) with the IRS. To elect S corporation treatment, an LLC files a form 2553 ([2]) with the IRS.

One reason that a business might choose to be organized as an LLC is to avoid “double taxation“. A traditional corporation is taxed on its income, and then when the profits are distributed to the owners of the corporation (i.e., the shareholders), those dividends are also taxed. With an LLC, income of the LLC is not taxed, but each owner of the LLC (i.e., each member) is taxed based on its pro rata allocable portion of the LLC’s taxable income, regardless of whether any distributions to the members are made. This single level of taxation can lead to significant savings over the corporate form. Similarly, under some circumstances, members of an LLC may deduct losses of the LLC on their personal tax returns.

Another reason that a business might choose to be organized as an LLC is to exploit the tax classification flexibility that LLCs allow. A new business experiencing losses might choose to operate as a sole proprietorship or partnership in order to pass through those losses to the owners. A slightly more established business might operate as an S corporation to save on self-employment taxes. A large mature business with many owners might operate as a C corporation.

Series LLC

Many form an LLC in order to protect personal assets from a legal claim relating to their real estate investment or business liabilities.[3] 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[4], 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 parnership 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.[5] 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.[6] 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 procedure for adding and deleting series is uncomplicated. Additional series can be added by simply amending the Series’ “limited liability company agreement” (equivalent to an operating agreement for other LLC’s). Under Delaware law, any particular series may be dissolved by 2/3rd’s approval of the ownership interests, or a simple majority if provided for in the operating agreement.

This method of liability segregation was first called the “Delaware Series LLC” because it was first approved in Delaware[7]. As of April 2005, Iowa and Oklahoma already had passed similar acts. Illinois followed suit in August of 2005 [8]. 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.[9] 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. To minimize the chances of one series being held liable for another’s liabilities, the owners of a Delaware Series LLC should do the following[10]:

  • Keep the assets and operations of each series separate from the other series. Each asset should be owned solely by one series. In other words, two or more series should not be co-owners of the same property.
  • Make sure each series is adequately capitalized.
  • Have each series files a fictitious business name statement in each county where it owns property. Each series should have its own name and the filing should emphasize the ownership of that series, for example, “Abracadabra LLC, Blackacre Series only”. This is to put creditors on notice.
  • All contracts, deeds, notes, etc. should be signed in the name of the series. Again, use something like “Abracadabra LLC, Blackacre Series only”.
  • A separate bank account should be maintained for each series.
  • Any loans between series should be properly documented.
  • Any transactions between series should be conducted in an arms’-length manner at fair market prices using appraisals.

LLC v. LLP

A limited liability company (LLC) differs from a limited liability partnership (LLP) in that the LLP is a partnership. LLP is a status elected by a partnership, a status that alters the rule of liability among that partners. The states have different rules on how the rule of partner liability is altered, so the state law in question must be examined.

Advantages and Disadvantages of an LLC (Limited Liability Company).

Advantages of an LLC

  • No requirement of an annual general meeting for shareholders (in some states, such as Tennessee and Minnesota, this statement is not correct).
  • No loss of power to a board of directors (although an operating agreement may provide for centralization of management power in a board or similar body).
  • Corporations are enduring legal business entities, with lives that extend beyond the illness or even death of their owners, thus avoiding problematic business termination or sole proprietor death. Planning for the death of an owner of an LLC is rather more difficult.
  • Corporations can raise capital through stock sales.
  • Much less administrative paperwork and recordkeeping.
  • Pass-through taxation (i.e., no double taxation).
  • Limited liability (meaning that the owners of the LLC, called “members,” are protected from liability for acts and debts of the LLC).
  • Using default tax classification, profits taxed personally (at the member level, not at the LLC level).
  • Check-the-box taxation. An LLC can elect to be taxed as a sole proprietor, partnership, S-corp or corporation, providing much flexibility.
  • Can be set up with just one natural person involved (but then, single shareholder corporations are allowed in many states).
  • 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 (i.e., See VA and Delaware LLC Acts).
  • LLCs in some states are treated as entities separate from their Members (See VA LLC Act), whereas in other jurisdictions case law has developed deciding LLCs are not considered to have separate juridical standing from their members (See recent D.C. decisions).

Disadvantages of an LLC

  • Many states, including Alabama, California, Kentucky, New Jersey, New York, Pennsylvania, Tennessee, and Texas, levy a franchise tax or capital values tax on LLCs. 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.
  • 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.
  • The possible lack of any operating agreement requirement can cause problems
  • Some people, such as new businessmen, may not be familiar with the governance of LLCs. Unlike corporations, they are not required to have a board of directors or officers.

See also

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