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Guide to Understanding
Limited Liability Companies

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 Structures

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

  • No requirement of an annual general meeting for shareholders.

  • No loss of power to a board of directors.

  • Much less administrative paperwork and recordkeeping.

  • Pass-through taxation (i.e., no double taxation), unless the LLC elects to be taxed as a corporation.

  • 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 are 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.

  • LLCs in some states can be set up with just one natural person involved.

  • 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).

  • 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

  • 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.

  • 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.

  • The LLC form of organization is 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).

  • Although there is no public requirement for an operating agreement, members who operate without one may run into problems.

  • 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.

  • The principals of LLCs use many different titles -- e.g., member, manager, managing member, managing director, chief executive officer, president, partner -- some of which are not correct. As such, it can be difficult to determine who actually has the authority to enter into a contract on the LLC's behalf.

Variations

  • A Professional Limited Liability Company (PLLC or P.L.L.C.) is a limited liability company organized for the purpose of providing professional services. Usually, professions where the state requires a license to provide services, such as a doctor, chiropractor, lawyer, accountant, architect, or engineer, require the formation of a PLLC. Exact requirements of PLLCs vary from state to state.

  • A Series LLC is a special form of a Limited liability company that provides extra protection for personal assets comprised of multiple business entities.

History By Country

Companies with limited liability exist in business law world-wide, however the Limited Liability Company is a specific legal structure defined by the laws of states of the United States and with quite different characteristics. Few other countries have similar structures.

United States

LLCs were first enacted by the state of Wyoming but can now be created under the laws of any U.S. state. They were chiefly inspired by the GmbH, a type of business organization in Germany, and by limitadas, a type of business organization available in many Latin American countries.

United Kingdom

There is no corporate structure in the United Kingdom corresponding directly to LLCs. The similar-sounding limited companies are more similar to U.S. corporations. The new form of Limited liability partnership (LLP) (created in 2002) is however similar to LLCs as it is tax neutral: member partners are taxed at the partner level, but the LLP itself pays no tax. They are treated as a body corporate for all other purposes including VAT.

Japan

Japan passed legislation in 2006 creating a new type of business organization, godo kaisha, a close variant of the American LLC.
Names and Abbreviations

Most states require that the company name contain one of the following terms, with some variation by state:

  • Limited Liability Company, L.L.C., or LLC

  • Limited Company, L.C., or LC

  • Ltd. Co.

Limited liability companies may not use the following terms on their own:

  • Company or Co. — reserved for corporations in most states

  • Limited or Ltd. — reserved for corporations in Texas (except in

  • Nevada, which allows the use of Limited or Ltd.)


 
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