Limited Liability Company
The Limited Liability Company (LLC), a hybrid of the partnership and the corporation, has become a popular legal alternative for business owners. Now available in almost all states, the LLC combines the benefits of limited liability and pass-through taxation, much like an S corporation. But the LLC's legal structure is much looser, allowing many companies that find S corporation status too restrictive to take advantage of its benefits. Small business owners are taking advantage of the LLC because it is easier to set up and maintain than a corporation.
Because the LLC is a fairly new option in the United States (it first became available in Wyoming in 1977, but most other states did not follow suit until the 1990s), the laws governing this business form are largely uninter-preted by court cases. In addition, each state has its own statutes concerning LLCs. Therefore, learning and keeping up with the laws that govern LLCs, which are still being fine-tuned, can be a tricky business. When considering the LLC option, consulting knowledgeable and up-to-date legal and tax advisors is a must.
ADVANTAGES OF FORMING AN LLC
Limited Liability
Like corporations, LLCs provide their members (owners) with protection from personal responsibility for the company's debt. Members are only liable to the extent of their investments in the company. If a customer slips and is injured on company property, a law suit may still bankrupt the business, but it cannot touch the personal assets of the LLC's members. This limited liability, then, is a great advantage over partnerships. In general partnerships, all members are liable for the company's debts and in a limited partnership, at least one member must still be liable.
Avoiding Double Taxation
Like S corporations, LLCs enjoy exemption from the double taxation required of C corporations. In other words, the LLC's profits pass through to the company's members who report their share of the profits on personal federal tax returns. The company itself does not pay a federal tax before the money is distributed to the members, as in the case of C corporations. But state and local taxes may still be levied against the LLC.
Flexibility of Income Distribution
According to some observers, one of the biggest benefits that small businesses enjoy when choosing LLC status is that allocation of profits and losses for tax purposes is easier under this form. Whereas the amount of profits the S corporation's shareholders report on their federal tax returns must be proportional to their share of stock, an LLC's members can determine amongst themselves how to divide their income as long as they follow the Internal Revenue Service's rules on partnership income distribution.
Simplicity
Another great advantage of LLCs over corporations is the ease of setting up and running them. Whereas incorporation can be an involved and costly process, all that is required to start an LLC is the filing of an Articles of Organization and the drafting of an Operating Agreement defining the company's policies and procedures (a filing fee, however, will still be required of LLCs). And whereas a corporation requires a board of directors, officers, and regular shareholders' and directors' meetings, an LLC is not required to observe such formalities in its operation. An LLC can be run from day to day essentially as if it were a partnership.
No Ownership Restrictions
The biggest drawback of forming an S corporation—the restrictions on the type and number of shareholders the corporation may have—is avoided by forming an LLC. The members of an LLC may be foreign nationals or other companies, both of which are prohibited from owning stock in an S corporation. In addition, there is no limit on the number of members an LLC may have, as there is with an S corporation.
Member Involvement in the Company
One problem with limited partnerships is that those partners who wish to protect themselves with limited liability (which may be all but one of the members) are prohibited from direct involvement in running the company. These partners may have only a financial investment in the firm. All members of an LLC may be directly involved in the company's management without jeopardizing their limited liability.
Attractive to Foreign Investors
Because LLCs have been in existence in Europe and Latin America for over a century, investors from those parts of the world are particularly knowledgeable about this business form. According to The Essential Limited Liability Handbook, "LLCs often prove to be the most familiar and least imposing business structure for foreign entrepreneurs who wish to enter the American market."
DRAWBACKS OF FORMING AN LLC
Newness
LLCs are still a very new option in most states (only Wyoming and Florida had LLC statutes on the books prior to the 1990s). This means that the statutes governing the establishment of LLCs are still evolving. And there is virtually no case history in the courts to indicate how these laws will be interpreted. The Internal Revenue Service is also still working out its position concerning LLCs, so it will be imperative for small business owners to solicit legal and tax advice on the current laws before making a decision about whether or not to form an LLC. And because the laws may change while the LLC is in existence, it will be important to keep on top of the developments in LLC statutes to determine whether it remains in the company's best interests to operate as an LLC.
Interstate Business More Complicated
Laws governing LLCs can vary widely from state to state, complicating the conduct of business across state lines. There are, as of yet, no uniform laws concerning LLCs, so an even greater knowledge of the state laws will be required of the company that does business in more than one state.
No Perpetual Existence
Most states require that an LLC's Operating Agreement set a limit to the company's existence (usually 30 years). And in the absence of a clause in the Operating Agreement providing for the continuance of the LLC in the event of the death or withdrawal of a member, the LLC will cease to exist when such events occur. The transfer of ownership is also more restricted for an LLC (like a partnership) than for a corporation.
Exclusions
A few types of entities cannot be organized as LLCs. These include banks, insurance companies, and non-profit organizations. The situation may change in the future. Banking groups are pressuring the IRS for rule changes which would permit them to form such entities, particularly newly constituted banks.
