Reasons to Form a Limited Liability Company (LLC)
UPDATED: February 7, 2020
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A limited liability company (LLC) is a hybrid organization that has characteristics of both a corporation and a partnership. Its members (comparable to corporate shareholders) receive interests in the LLC in exchange for property, money, or services. Like a corporation, owners receive liability protection. Because of its hybrid structure, an LLC can be a good alternative to those who operate a sole proprietorship or a partnership and need to have more protection from individual liability for debts or lawsuits. How and where the LLC is formed will determine the extent of tax benefits and liability protection offered through a limited liability company.
How to Establish a Limited Liability Company
A limited liability company is a separate legal entity for purposes of limited liability of its members in most states. Even though an LLC is not a corporation, states have adopted state-specific rules regarding the formation of an LLC. To create an LLC, members file articles of organization with the state and pay filing fees. When an LLC is formed, the owners should adopt rules, bylaws, and operating agreements.
Operating agreements are similar in concept to a partnership agreement. They explain the operation and management of the business. If none are adopted, many states will have default rules. Regardless, adherence to these rules is important to preserve the limited liability protection offered by an LLC business. When an owner actively engages in fraud or misrepresentation, a plaintiff could potentially "pierce the corporate veil." This means that even though an owner would normally have a limited liability, they can lose the protection through certain misconduct.
Limited Liability Companies and Tax Benefits
The tax benefits of an LLC will also turn on how the LLC is formed. One advantages of forming an LLC is the avoidance of expensive self-employment taxes. Many LLC’s are set-up similar to partnerships, which means that each partner pays their share of taxes. However, when the LLC is formed, the LLC can complete paperwork to elect to have the LLC, instead of the partners, pay the taxes. The LLC or the owners of the LLC may also be required to pay other types of taxes to the state where the LLC is formed.
Besides the flexible tax options and the limited liability, the LLC is an attractive option to many business owners because it has the freedom from many of the legal formalities that govern corporations. Just a few include: annual reports, director meetings, and shareholder requirements.
Getting Help with Establishing a Limited Liability Corporation
Before jumping into an LLC, business owners should know that there has been a lot of fanfare regarding this form of business enterprise and the law is still germinating. Compared to other forms of business entities, a limited liability company is a relatively new type of business organization. The rules regarding the formation and operation of LLCs are not uniform; each state has its own set of statutes governing LLCs. The rules from one state to another may provide different degrees of liability and tax consequences. These rules must also dovetail with IRS guidelines, which are in constant evolution. Therefore, it is necessary to have the advice of an attorney to determine how and when a limited liability company best suits your business situation.