Limited Liability Company (LLC) - Business Tip # 9

A limited liability company (LLC) is a legal structure that combines many of the advantages offered by both partnerships and corporations. In a nutshell, an LLC combines the benefits of a corporation's limited liability and a partnership's tax status.

The LLC is a popular legal business structure, because it allows the entrepreneur to run a business free from ever-threatening unlimited personal liability and enjoy partnership tax status. Without having to fear the loss of his house, car, and savings to a business liability, the entrepreneur can focus his energy and money on developing a competitive enterprise that will benefit the economy and society as a whole and maybe even the business owner! Precisely this view is part of the logic behind the very flexible LLC legislation. Business-friendly legislation encourages the entrepreneurship and commercial activity that drive human progress and national economies.

The large-scale emergence of limited liability companies in the United States is a relatively recent phenomenon, though, and it most recently dates back to 1988 when the IRS granted LLCs the federal income tax status of partnerships. Since the LLC as a legal business structure is so young, laws that regulate LLCs are still evolving very quickly. Most states have not adopted uniform legislation for LLCs, and the regulations that govern the creation, organization, and handling of LLCs vary greatly from state to state. Both rapid change and regional differences make LLC legislation a hard topic to discuss in detail. If you believe that a limited liability company is the legal structure that suits your needs best, you should obtain a copy of LLC legislation affecting your state and purchase the most current book specializing in LLCs that you can find. A copy of your state's LLC legislation may be available on the World Wide Web or from your state's corporate division of the secretary of state. Most public libraries will also carry copies in their business sections. For a comprehensive guide on forming and operating an LLC, we recommend the latest edition of How to Form and Operate a Limited Liability Company by Gregory Damman (Self-Counsel Press, Inc.). Since LLC legislation is still developing rather briskly, the most important consideration in your purchase should be the recency of the information you obtain.

The basic procedure to form an LLC is simple and is comparable to drafting a partnership agreement or articles of incorporation. Forming an LLC usually requires little more than filing articles of organization, sometimes called a certificate of formation, with the secretary of state or other appropriate state agency. The information required within the articles of organization varies between states, and you will either have to order information or fill-in-the-blank forms pertinent to your area of intended operation from the secretary of state. Information for your state can also be found in the government section of your local telephone book.

Every state has slightly different requirements for filing articles of organization, and the filing fees vary significantly. For example, after reading through the information that several states require, we are convinced that the Massachusetts version is one of the simplest to file. However, Massachusetts charges a whopping $500 to file articles of organization; this sum is one of the highest around and is shameful compared to the mere $50 it costs in some other states. The articles of organization must contain the name of the company, an address for the company within the state, the name and address of the registered agent for the company, a dissolution date, the names and addresses of managers, the general character of the company's business, and the names of persons authorized to file documents with the secretary of state on behalf of the company.

Ownership:

Limited liability companies may be owned by many different types of domestic and international entities. Membership in LLCs is legally possible not only for individuals but entire partnerships, corporations, and other groups. The terms of ownership within the LLC are mutually agreed upon by the owners. Any agreements may be written either in the articles of organization or within an operating agreement drawn up by the owners. The owners of an LLC have tremendous freedom in dividing among themselves the rights and responsibilities of running the company. The owners may distribute the LLC's losses and gains according to any formula they see fit, and the same freedom is true for choosing a management system. While some members may be actively involved in handling the company's daily affairs, others may have virtually no management rights. As long as no laws are ignored or broken, an LLC has a lot of flexibility in shaping its own operating rules.

Members of an LLC may only transfer their interest in the company if all other owners approve the transaction. The withdrawal or death of any member dissolves the LLC, unless all remaining members agree to continue.

Liability.

Perhaps every entrepreneur's nightmare is losing his personal assets to a lawsuit, a bad loan, or some other business obligation. No matter how much liability insurance you purchase, you ultimately have unlimited personal liability for a sole proprietorship or general partnership. The limited liability company's greatest attraction is the legal shield with which it guards its owners from unlimited personal liability. When an LLC is in debt or loses a lawsuit, its owners are only liable up to the amount of their initial capital contributions to the company.

In theory creditors and plaintiffs can only go after the LLC's property when they seek the payment of a business debt or obligation and cannot touch the personal assets of its owners. While this liability arrangement of an LLC may sound ideal to you now, the principles do work somewhat differently in real life. Even though the LLC's shield protects your personal assets from business obligations and debts, you must still worry about personal liability and negligence. If a client is hurt or the payment of a debt jeopardized because of your own negligence, the LLC's liability shield cannot protect you, and you are still personally liable for your actions. You also shouldn't kid yourself regarding loans by banks or other large financial institutions. If a bank is not absolutely sure that your LLC will be able to repay a loan on time, it will demand that at least one of the LLC's members guarantee the loan personally. Once you personally guarantee a loan, you are just as vulnerable to liability resulting from this debt as a sole proprietor.

Finally, the absence of unlimited personal liability does not imply the lack of legal responsibilities with which a member of an LLC must comply It would not be advisable, for instance, to take out a loan on behalf of the LLC, pay the money out to its members as dividends, and claim the creditor is out of luck due to the LLC's insolvency. Most states' LLC statutes contain provisions that specify a limit to the amount of an LLC's capital that can be paid out as dividends.

Overall the LLC's liability shield is a safe and efficient way to protect yourself against financial ruin, although you should be wary of overestimating its power. The LLC is a fantastic way to drastically limit your liability exposure, but you are not completely immune.

Taxation:

Besides limited liability, partnership tax status is the second most important selling point for the LLC legal structure. In fact, it was the decision by the IRS in 1988 to give LLCs the same tax benefits from which partnerships had already profited for years that sparked the rise in LLC activity. The LLC has the freedom to divide its profits or losses among its members in any way it deems advantageous, and individual gains or losses by members are calculated and reported each year. Each member then declares his or her share of earnings or losses along with other income on his or her personal income tax return. Since members of an LLC can also be corporations or partnerships, dividends from the LLC are taxed with other earnings the member has.