A limited liability company (LLC) is a specific form of business in the United States that shares the characteristics of the SARL (including the limitation of the liability of the owners of the company) and tax advantages usually reserved for other structures such as the partnership or the sole proprietorship. It is a legal form of company that protects its owners from unlimited liability in the vast majority of states in the United States.
A Limited liability company is a hybrid business entity with both some characteristics of a corporation and those of a partnership or sole proprietorship (depending on the number of owners of the business). Although it is a commercial entity, it is a type of unincorporated association and it is not a corporation. The main feature that an LLC shares with a corporation is limited liability, and the main feature it shares with the partnership is that it is exempt from income tax. This form is often more flexible than that of a corporation and is well-suited for businesses with a single owner.
It is important to understand that limited liability does not mean that owners are always fully protected from personal liability. Courts can sometimes pierce the corporate veil of corporations (or LLCs) when certain types of fraud or misrepresentation are involved.
LLC Flexibility and Default Rules
The phrase “except as otherwise provided in the Operating Agreement” (or its equivalent) is found in all existing LLC articles and is responsible for the flexibility LLC members have to decide how their LLC will be run (provided it does not go outside the legal limits). State laws generally provide “default” rules for how an LLC will be governed unless the operating agreement provides otherwise.
Similarly, the phrase “except as otherwise provided by law” is also found in all corporate law statutes, but often refers only to a narrower set of issues.
For federal income tax purposes, LLCs are treated as flow-through entities by default. If there is only one member of the company, the LLC is treated as an “ignored entity” for tax purposes, and an individual owner will have to report the income of the LLC on their individual tax return. For LLCs with multiple members, the LLC is considered a partnership and must file Form 1065 with the IRS. Members of the LLC will be treated as partners, and each will receive a Form K-1 reporting the LLC’s share of profits or losses that will need to be reported on that member’s tax return.
As an option, LLCs can also elect to be taxed as a corporation by filing IRS Form 8832. They can be treated as a C corporation (taxation of the entity’s income prior to any dividend or distributions to members and then taxation on dividends or distributions once received as income by members), or as an S corporation. Some commentators have recommended a taxed LLC like an S corporation as the best possible structure for small businesses. It combines the simplicity and flexibility of an LLC with the tax advantages of an S-corporation (self-employment tax savings).
Benefits of LLC
- The choice of eligibility for taxation. An LLC can elect to be taxed as a sole proprietorship, partnership, C corporation, or S corporation (as long as it would otherwise qualify for this tax treatment), which provides a great deal of flexibility.
- Limited liability, which means that the owners of the LLC, referred to as “members,” are protected in whole or in part from liability for the acts and/or debts of the LLC depending on the state’s protection laws.
- Much less paperwork and record keeping than for a corporation.
- Incomplete tax pass-through (e.g., no double taxation) unless the LLC is taxable as a C corporation.
- Using the default tax classification, profits are taxed personally at the member level, not at the LLC level.
- In some states, an LLC can be incorporated with only one natural person involved.
- Less risk of being “robbed” by the sale of feudal acquisitions (more protection against investor “hunger”).
- The LLC is a “pass-through entity” from a tax point of view, i.e. semi-transparent from a tax point of view.
- While there is no legal requirement for an operating agreement in most states, members of a multi-member LLC that operate without the consent of other members may run into problems. Unlike state corporation laws which are very well developed and provide a variety of governance and protection provisions for the corporation and its shareholders, most states do not dictate detailed governance and protection provisions for members of a limited liability company. Thus, in the absence of such statutory provisions, members of an LLC must establish governance and protection provisions under an operating agreement or similar governing document.
- It can be more difficult to raise financial capital for an LLC, as investors may be more comfortable investing funds in a better-understood corporate form with a view to a possible IPO. One possible solution could be to form a new corporation and merge, leading to the dissolution of the LLC and its conversion into a corporation.
- Many states, including Alabama, California, Kentucky, New York, Pennsylvania, Tennessee, and Texas, levy a franchise or capital tax on LLCs (Texas replaced its franchise tax with a “margin tax” in 2007). In short, this tax, the franchises or business liens, is the “royalty” that an LLC pays to 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, a combination of these factors, or simply a lump sum, as in Delaware. Effective in Texas in 2007, the franchise tax is replaced by the Texas Business Margin Tax. In most states, however, these fees are nominal, and only a handful of states tax a tax comparable to that imposed on corporations.
- The District of Columbia considers LLCs to be taxable entities, eliminating flow-through entities by subjecting members to double taxation. Typically, LLCs will elect to be taxed as a partnership in order to avoid the double taxation that occurs in corporations. This allows companies to allocate their income among members who then report it on their personal tax returns.
- Renewal fees can sometimes be higher. Maryland, for example, charges corporations with and without corporations $120 for the original charter, and $100 for the LLC. The fee for filing the following year’s annual return is $300 for corporations and LLCs, but zero for corporations without shares. In addition, some states, such as New York, impose a publication requirement on the formation of the LLC, which requires members of the LLC to publish a notice in newspapers in the region where the LLC is located stating that the LLC has been incorporated. For large metropolitan areas (e.g. New York City), the cost of a publication can be significant.
- The management structure of an LLC may not be familiar to many. Unlike corporations, they are not required to have a board of directors or officers (this could also be seen as an advantage for some).
- Tax jurisdictions outside the U.S. are likely to treat a U.S. LLC as a corporation, regardless of whether it is treated for U.S. tax purposes, such as if a U.S. LLC does business outside the U.S. or if a resident of a foreign jurisdiction is a member of a U.S. LLC
- LLC officers use many different titles — for example: 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 behalf of the LLC.
Variants of CLL
- A Professional Limited Liability Company (PLLC, P.L.L.C., or P.L.) is a limited liability company organized for the purpose of providing professional services. Usually, professions where the state requires a license to provide services, such as doctors, chiropractors, lawyers, accountants, architects, landscape architects, or engineers, require the formation of a PLLC. However, some states, such as California, do not allow limited liability companies to engage in the practice of a regulated profession. The exact requirements for PLLCs vary from state to state. Generally, the members of a PLLC must all be professionals practicing the same profession. In addition, the limitation of members’ personal liability does not extend to malpractice claims.
- A series LLC is a special form of LLC that allows a single LLC to separate its assets into separate series. For example, a series LLC that buys separate real estate may put each of those properties in a separate series so that if the lender excludes on one piece of property, the others are not affected.