- Often incorrectly called a "limited liability corporation" (instead of company),
- it is a hybrid business entity having certain characteristics of both a corporation and a partnership or sole proprietorship (depending on how many owners there are).
- The primary characteristic an LLC shares with a corporation is limited liability, and
- the primary characteristic it shares with a partnership is the availability of pass-through income taxation. It is often more flexible than a corporation and it is well-suited for companies with a single owner.
Terminology
- Member
- LLC members are the owners of the LLC much as shareholders are the owners of a corporation or the partners of a partnership. Like shareholders, a member's liability to repay the LLC's obligations is limited to his or her capital contribution. Members may be natural persons, corporations, partnerships, or other LLCs.
- Membership Interest
- A member's ownership interest in an LLC is often called a membership interest. Membership interests are often divided into standardized units which, in turn, are often called shares or units. Unless otherwise provided for in the operating agreement, a member's right to receive distributions or exercise member rights over the LLC is proportionate to their membership interest. Membership interests and member rights are regulated by state law.
- Manager
- In most states, LLCs may be managed by their members in proportion to their membership interests. In some states such as Georgia, however, each member has an equal right to participate in the management of the LLC unless there is a specific provision in the articles of organization or operating agreement to the contrary. Many LLC operating agreements, however, provide for a manager or board of managers to oversee or run the day-to-day operations of the LLC. The managers are elected or appointed by members and may also be, if so provided in the operating agreement, removed by members. A member may also be a manager. There is some confusion as to how to treat someone who is identified as the "managing member" of an LLC. Although suggestions have been made on earlier versions of this entry that a "managing member" should be treated as a manager, the better treatment is consider a "managing member" as being a member.
- Articles of Organization
- All LLCs must file evidence of their existence with the secretary of state (or some governmental office) of the state where they choose to be organized. The Articles of Organization serve this purpose.
- Operating Agreement
- The Operating Agreement of an LLC is the document most important to the governance of an LLC because it determines, defines, and apportions the rights of the members and the managers if any. The operating agreement generally is not filed with the secretary of state (or other governmental office) .
Management
LLCs may be either member-managed or manager-managed. A member-managed LLC may be governed by a single class of members (in which case it approximates a partnership) or multiple classes of members (in which case it approximates a limited partnership). Choosing manager management creates a two-tiered management structure that approximates corporate governancewith the managers typically holding powers similar to corporate officers and directors. The LLC's operating agreement (the LLC version of a partnership agreement or a corporation's bylaws) determines how the LLC is managed. Corporations, S-corporations, Limited Liability Partnerships, Limited Partnerships, Limited Liability Limited Partnerships, and LLCs lie along a spectrum of flexibility with LLCs being the most flexible, and thus preferable, for many businesses.
[edit]Income taxation
For U.S. Federal income tax purposes, LLCs that are treated as partnerships use IRS Form 1065. 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 and the LLC governing the membership, management, operation and distribution of income of the company.
Under some circumstances, however, the members (the LLC version of shareholders or partners) may elect for the LLC to be taxed like a corporation (taxation of the entity's income prior to any dividends or distributions to the members and then taxation of the dividends or distributions once received as income by the members).
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.
With federal income tax treatment as a partnership, LLCs can lose the tax advantage. 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.
[edit]Advantages
- Check-the-box taxation. An LLC can elect to be taxed as a sole proprietor, partnership, S corporation or C corporation (as long as they would otherwise qualify for such tax treatment), providing much flexibility.
- Limited liability, meaning that the owners of the LLC, called "members," are protected from some or all liability for acts and debts of the LLC depending on state shield laws.
- Much less administrative paperwork and record keeping than a corporation.
- Pass-through taxation (i.e., no double taxation), unless the LLC elects to be taxed as a C corporation.
- Using default tax classification, profits are taxed personally at the member level, not at the LLC level.
- LLCs in most states are treated as entities separate from their members, whereas in other jurisdictions case law has developed deciding LLCs are not considered to have separate legal standing from their members (see recent D.C. decisions).
- 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 (see, for example, the Virginia and Delaware LLC Acts).
- 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
[edit]Disadvantages
- Although there is no statutory requirement for an operating agreement in most states, members of a multiple member LLC who operate without one may run into problems as, unlike state laws regarding stock corporations, which are very well developed and provide for a variety of governance and protective provisions for the corporation and its shareholders, most states do not dictate the governance and protective provisions for the members of a limited liability company. Thus, in the absence of such statutory provisions, the members of an LLC can only establish governance and protective provisions pursuant to contract, in the form of an operating agreement.[which?].
- It may be more difficult to raise financial 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 into a corporation.
- Many states, including Alabama, California, Kentucky, 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.
- Renewal fees may also be higher. Maryland, for example, charges a stock or nonstock corporation $120 for the initial charter, and $100 for an LLC. The fee for filing the annual report the following year is $300 for stock corporations and LLC, and zero for non-stock corporations. In addition, certain states, such as New York, impose a publication requirement upon formation of the LLC which requires that the members of the LLC publish a notice in newspapers in the geographic region that the LLC will be located that it is being formed. For LLC's located in major metropolitan areas (i.e. New York City), the cost of publication can be significant.
- Some creditors will require members of up-and-starting LLCs to personally guarantee the LLC's loans, thus making the members personally liable for the debt of the LLC.
- The management structure of an LLC may be unfamiliar to many. Unlike corporations, they are not required to have a board of directors or officers.
- Taxing jurisdictions outside the US are likely to treat a US LLC as a corporation, regardless of its treatment for US tax purposes, for example if a US LLC does business outside the US or a resident of a foreign jurisdiction is a member of a US LLC.
- 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).[citation needed]
- The principals of LLCs use many different titles—e.g., member, manager, managing member, managing director, chief executive officer, president, and partner. As such, it can be difficult to determine who actually has the authority to enter into a contract on the LLC's behalf.
History by country
Companies with limited liability exist in business law worldwide, however the limited liability company is a specific legal structure defined by the laws of states of the United States and with quite distinct characteristics. Several other countries have similar structures.
[edit]United States
A Limited Liability Company (LLC) is a relatively new business structure allowed by state statute.[1] The LLC is 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.[2]
In the United States, the first limited liability company act appeared in Wyoming in 1977 as special interest[clarification needed] legislation for an oil company.[3] In 1980, the Internal Revenue Service issued a private letter ruling to an LLC formed under Wyoming LLC Act indicating that the IRS would treat the LLC as a partnership for federal tax purposes.[4] However, later that year, the IRS proposed regulations that would deny partnership classification to any business entity in which no member bore personal responsibility for the entity’s liabilities. [5] In 1982, Florida adopted an LLC act modeled on Wyoming’s LLC Act.[6] Due to uncertainty over the tax treatment of LLCs, no other states introduced LLC legislation until after 1988.[7] In 1988, the IRS issued a revenue ruling stating that it would treat a Wyoming-style LLC as a partnership for tax purposes.[8] By 1996, nearly every state had enacted an LLC statute.[9] The National Conference of Commissioners on Uniform State Laws adopted the Uniform Limited Liability Company act in 1996 and revised it in 2006.[citation needed]
Names and abbreviations
Most states require that the company name contain one of the following terms, with some variation by state:
- Limited Company, L.C., or LC
- Limited Liability Company, L.L.C., or LLC
- Ltd. Co.
Limited liability companies may not use the following terms on their own:
- Company or Co. — reserved for corporations in most states (the use of the term "company" alone is not valid for a corporation in some states)
- Limited or Ltd. — reserved for corporations in Texas (except in Nevada, which allows the use of Limited or Ltd.)
[edit]See also
- GmbH, a European form of the LLC
- Besloten Vennootschap (B.V.), a Dutch private limited company
- Limited liability
- LLP
- Series LLC
- Types of business entity
- Uniform Limited Liability Company Act
- good standing
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