The Limited Liability Company (LLC)
By Aaron Larson
August, 2004; Last Reviewed Dec., 2010.
- What Businesses Qualify?
- Limited Liability
- Articles of Organization
- The Operating Agreement
- Annual Fees
- Securities Law
- Know Your Local Law
A limited liability company, or LLC, is a business entity that enjoys many of the advantages of being a corporation, including limited liability, while avoiding many of the more singificant burdens imposed on corporations, and while retaining many of the characteristics of unincorporated entities such as partnerships and sole proprietorships.
While the owners of a corporation are referenced as shareholders or stockholders, the owners of a limited liability company are often referenced as "members". It is possible for an LLC to be formed by a single individual, in which case it is usually referenced as a "single member LLC".
Most businesses will qualify to form as LLC's. Banks and insurance companies do not qualify to form as LLC's.
Some states restrict professionals such as lawyers, accountants and doctors from forming as LLC's, or have a similar corporate form, the Professional Limited Liability Company (PLLC), for professional practices.
The LLC can be attractive to businesses which might otherwise form as S Corporations, but would either have too many shareholders to qualify, or wish to include owners who are not citizens or residents of the United States.
Members of a limited liability company enjoy protection from individual liability similar to that afforded to corporate shareholders. That is to say, if a business is sued or is unable to pay its debts, the creditors can ordinarily only reach the LLC's assets and cannot reach the assets of the members. Some states permit an action to "pierce the corporate veil" of an LLC and to attempt to reach the personal assets of an LLC whose members who have engaged in wrongful conduct. Whatever the state of the law in any givne jurisdiction, owners of an LLC should anticipate that if they use the LLC to advance their personal purposes or to perpetrate fraud, courts will hold them personally liable for the LLC's associated liabilities.
Also, members of an LLC can potentially be held responsible for their own negligence and misconduct as well as for the actions of employees under their direct supervision, for actions intended to damage or defraud the LLC, and for debts of the LLC which they personally guaranteed.
When starting an LLC, you must prepare Articles of Organization, to be filed with the Secretary of State, along with a filing fee. Most states offer approved forms for completing and submitting articles of organization. Typically, the Articles of Organization include the name and address of the LLC, the names and addresses of the initial members (owners), and the name and address of the LLC's registered agent.
In some states, you must publish an announcement of the formation of your LLC, or the conversion of your existing business to an LLC, in a newspaper qualified to publish legal notices prior to filing your Articles of Organization with the state. You can usually find out if your local newspaper qualifies to publish your notice by inquiring with the state or with the paper itself.
LLC, the location of its principal office, the names and addresses of the LLC's owners and the name and address of the LLC's registered agent (a person or company that agrees to accept legal papers on behalf of the LLC
When you starting an LLC, although generally not required by law, the members should create and approve an operating agreement for the LLC. The operating agreement governs the operation and management systems for the LLC, and can direct the manner in which profits are to be divided. It can also create procedures for the departure of LLC members, or the addition of new members, and the valuation of the LLC for purposes of buy-in or buy-out. It should also reflect the ownership interest of the members, their associated voting rights, and how profits are to be distributed among the owners.
Without an operating agreement, the basic operation of the LLC will be governed by state law, which may not be advantageous to the LLC or the business it conducts. Under typical state law, if a member of an LLC quits, the LLC ceases to exist. Many LLC's would prefer that their operations continue even if a member departs, and thus provide for that contingency in their operating agreements such that the LLC continues to operate with its remaining members.
Unlike corporations, LLC's are not required to hold annual meetings or prepare annual reports. An LLC may nonetheless find it beneficial to voluntarily hold regular meetings, or to provide in its operating agreement that meetings be held before certain actions deemed important by the LLC's members.
There are a variety of form operating agreements available in most states, which can be modified to suit the needs of the LLC and its members. It is helpful to have an attorney review the proposed final version of an LLC's operating agreement prior to its formal adoption.
Some states require that LLC's pay an annual franchise tax or registration fee.
The income of a limited liability company passes through to its members, who report the income on their personal tax returns. For tax purposes, a single member LLC is treated as a sole proprietorship, and a multiple member LLC is treated as a partnership. The LLC itself does not ordinarily pay taxes on its own behalf as a separate entity. An LLC will ordinarily be required to file an annual informational tax return with the IRS.
The income members earn remains subject to income and "self employment tax" (Medicare and Social Security contributions), and members are responsible to pay those taxes at the end of the year. Members who do not play a role in the management of the LLC, but simply receive a share of the profits by virtue of their ownership interest, may be exempt from paying self-employment taxes. In most cases, members will be required to make quarterly payments of their estimated tax liability, to both the state and to the federal government.
It is possible for an LLC to elect to be taxed in the same manner as a C Corporation, in which case the LLC pays taxes on its retained profits at the corporate tax rate. As this election will last for a minimum of five years, and as there may be tax consequences for switching back to pass-through taxation, careful consideration must be taken before exercising this option, including the possibility that the business would be better served by becoming a corporation.
You should discuss the manner in which your LLC will be taxed with a qualified financial professional.
For most LLC's, there are a relatively small number of owners of the LLC who also act as active participants in its management, and securities laws don't come into play. However, if an LLC intends to have owners who are not actively involved in the business, or sell ownership interests in order to raise capital, it may be required to follow certain procedures and registration requirements set forth in state and federal securities laws. Before engaging in that type of activity, it will benefit an LLC to obtain legal advice, and to try to qualify for any applicable exemptions to the securities laws.
Before you opt to become an LLC, make sure you have a full understanding of the state laws which will govern your operations, including any limits on the duration of your LLC, and the amounts of any filing fees or annual fees associated with starting and maintaining an LLC.
Copyright © 2004 - 2011 Aaron Larson. All rights reserved. No portion of this article may be reproduced without the express written permission of the copyright holder. If you believe you may lawfully use a quotation, excerpt or paraphrase of this article under the Fair Use exception to copyright law, except as otherwise authorized by the author of the article, you must cite this article as a source for your work and include a link back to the original article from any online materials that incorporate or are derived from the content of this article.