A limited liability company (LLC) is a business entity that contains characteristics of both a partnership and a corporation. An LLC is like a corporation in that it provides its owners (also called members) with limited liability, as a corporation does for its shareholders. This means that by law, the owners of the LLC are usually not personally liable for any debts of the business, aside from the value of their investment in the business.
This is different from a partnership, in which each individual is personally responsible for all the debts of the entity. In most jurisdictions, an LLC is treated like a partnership in that pass-through income taxation is available to the business. Pass-through income taxation means the income of the entity is treated as the income of the individuals that own the entity. This means that the entity can be treated like a non-entity for taxation purposes.
Generally the owners of a LLC can choose how they want it to be taxed, either as a sole proprietor, a partnership, or a corporation. This “check the box” taxation can provide the members with a great deal of flexibility. If the owners choose to be taxed like a partnership, the pass-through income taxation allows the LLC to avoid the “double-taxation” given to corporations, because the IRS will not tax the LLC as an entity. There is also far less administrative work involved in a LLC than in a corporation, and in some states, an LLC can be formed with just one natural person.
Assets are easier to remove in an LLC than in a corporation and a majority of states, there is no requirement that the shareholders have an annual meeting. There is also no requirement that there is a board of directors, but there is the option of setting up an operating agreement to centralize the management. Further, in most jurisdictions an LLC is treated as a separate entity from its owners, meaning that the owners enjoy liability protection from the acts and debts of the LLC. It should be noted however, that some creditors will ask you to waive this liability protection before they give you a small-business loan.
Because many investors feel more comfortable with investing in a corporation, which has a better-understood internal structure than the flexible LLC, owners of the LLC may find it more difficult to raise financial capital than they would in a corporation. For example, an LLC is not required to have a strict management structure, like the board of directors that is required in a corporation. Also, in some states, LLCs are given a franchise tax, and renewal fees may be higher for an LLC than for a corporation.
Because LLC laws differ within states, the LLC can be treated differently depending on which state the LLC is doing business with. If 35% or more of the LLCs losses can be attributed to individuals who are non-managers, the LLC may lose the ability to do its accounting through the cash method. Also, while there may be benefits to pass-through income taxation, the down side is that the earnings of the LLC are subject to self-employment taxation. Further, many foreign jurisdictions treat LLC as if they were corporations for tax purposes.
LLCs are very easy to form. The first step is to choose a name for your LLC that complies with the rules of your state. For instance, you must make sure that your name does not violate another businesses trademark. Also, you will not be able to have the same name as another registered LLC, and “Limited Liability Corporation,” or “LLC” must always follow your business name.
After you have chosen your name, you will need to file paperwork, called the Articles of Organization, with your Secretary of State’s office. This is usually a simple process, and can be done by finding the rules and fees on your Secretary of State’s official website. Most of the time states will have a simple fill-in-the-blank form that asks for basic information. Next, while it is not mandatory to have an operating agreement, it is a good idea to create one. This will give your LLC a solid management structure that will be attractive to potential investors.
An operating agreement includes the members’ percentages of interest, duties, voting powers, how losses and profits will be allocated, and other types of managerial requirements. After you have completed these steps, usually the only thing left to do is to obtain the required state business licenses and permits. Also, some states will require that before your LLC is official, it be “published” in your local newspaper for several weeks. While it is not always necessary to hire a lawyer to form a LLC, it is advisable that you have a business attorney look over your paperwork, so that your interests are protected.
Before you dissolve your LLC, you must determine each individual’s percentage of interest in the LLC, as well as all of your LLC assets. If you are dissolving your LLC amicably, then the procedure is usually fairly easy. You must file a number of documents with your state, as well as Form 966 with the IRS. Further, you must inform your creditors of where to send their claims, and liquidate the LLCs assets. If you want to dissolve your LLC because you are having problems with other members, this can be a more difficult process. Usually, if you get two-thirds approval, you can continue with dissolving your LLC. If you do not have this approval, you may end up in court.