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Limited liability company

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A limited liability company (denoted by L.L.C. or LLC) is a form of legal entity which offers limited liability to its owners (like a corporation) and pass-through taxation (like a partnership or sole proprietorship).

[edit] Overview

The limited liability company form was introduced relatively recently to the United States. An LLC provides limited personal liability to owners of its equity interest, similar to a corporation and a limited liability partnership and in contrast to a general partnership or sole proprietorship. A variant of the LLC available in some jurisdictions, typically limited to licensed professionals such as lawyers, physicians, or engineers, is the professional limited liability company (denoted by "P.L.L.C." or "PLLC"). Although some people refer to LLC as "limited liability corporations", the correct terminology is "limited liability company".

Basically, an LLC allows for the flexibility of a sole proprietorship or partnership structure within the framework of limited liability, such as that granted to corporations. An advantage of an LLC over a limited partnership is that the formalities required for creating and registering LLCs are much simpler than the requirements most states place on forming and operating corporations; because of the lack of requirement for annual meetings of shareholders (LLCs have "members") or bylaws, for instance - however, most LLCs will choose to adopt an operating agreement or limited liability company agreement to provide for the governance of the company, and such agreement is generally more complex than a corporation's bylaws. Note, too, that some states (such as New York) require that the LLC have an operating agreement.

For purposes of U.S. tax law, a feature of the LLC is that an LLC can elect how it should be treated for federal and often for state income tax purposes. An LLC with one owner, for example, is treated as a sole proprietorship by default (when an LLC has a single owner - either an individual or an entity - it is a disregarded entity for federal tax purposes) but this one owner LLC can also elect to be treated as a C corporation or as an S corporation. Further, an LLC with more than one owner is treated as a partnership by default but a multiple owner LLC can also elect to be treated as a C corporation or as an S corporation. To elect C corporation treatment, an LLC files a form 8832 with the IRS. To elect S corporation treatment, an LLC files a form 2553 with the IRS.

One reason that businesses choose to be organized as an LLC is to avoid "double taxation." A traditional corporation is taxed on its income, and then when the profits are distributed to the owners of the corporation (i.e., the shareholders), then those dividends are also taxed. With an LLC, income of the LLC is not taxed, but each owner of the LLC (i.e., each member) is taxed based on its pro rata allocable portion of the LLC's taxable income, regardless of whether any distributions to the members are made. This single level of taxation can lead to significant savings over the corporate form. Similarly, under some circumstances, members of an LLC may deduct losses of the LLC on their personal tax returns.

Another reason that businesses choose to be organized as an LLC is to exploit the tax classification flexibility that LLCs allow. A new business experiencing losses might choose to operate as a sole proprietorship or partnership in order to pass through those losses to the owners. A slightly more established business might operate as an S corporation to save on self-employment taxes. A large mature business with many owners might operate as a C corporation.

[edit] LLC v. LLP

A limited liability company (LLC) differs from a limited liability partnership (LLP) in that the LLP has the organizational flexibility of a partnership. Furthermore, LLCs are more likely to be subject to a state's franchise taxes.

[edit] LLC vs. other forms of doing business

[edit] Advantages of an LLC

  • No requirement of an annual general meeting for shareholders
  • Pass-through taxation (i.e. no double taxation).
  • 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 taxed personally (at the member level, not at the LLC level).
  • Can be set up with just one natural person involved

[edit] Disadvantages of an LLC

  • Many states, including Alabama, California, Kentucky, New Jersey, New York, Pennsylvania, Tennessee, Texas, and West Virginia, levy a franchise tax or capital values tax on LLCs. 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.
  • As compared to a sole proprietorship or a corporation, an LLC may have more complicated accounting and tax reporting. Partnership accounting requires adjustments not found in other entities.
  • It may be more difficult to raise capital for a LLC, as investors may be more comfortable investing funds in the better-understood corporate form with a view toward an eventual initial public offering. Also, due to certain tax rules, tax exempt investors (such as pension funds) often will not invest in LLCs.
  • LLCs that fail to adopt an operating agreement can find themselves with significant problems because of the statutory provisions which control in the absence of an operating agreement.
  • Some people may not be familiar with the LLC structure and may demand actions by Directors or by Shareholders or officers. While an LLC may establish something akin to a board of directors and can designate officers, it is not required to do so.

[edit] See also

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[edit] External links

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This entry includes content from the following Wikipedia article: Limited liability company