Formation of Limited Liability Companies (LLCs)
What is a Limited Liability Company?A Limited Liability Company (LLC) is a hybrid business entity that combines the tax benefits and less formal business structure of partnerships and sole proprietorships with the personal asset protections of a formal corporate structure.
Partnership-Type Management
Much like a partnership, LLCs allow for a less structured form of management. The LLC members, as owners, can make business and management decisions without the need for a formal process as often seen in larger corporate entities. Instead, members can establish their roles in the LLC with an LLC Operating Agreement.
An LLC Operating Agreement is a legally binding document drafted by an attorney which establishes the roles and decision making powers of each member of the LLC. There is no filing requirement for the LLC Operating Agreement. The Operating Agreement, when properly drafted, can establish contingencies for the expansion and succession of the LLC. LLCs also have the advantage of fewer filing requirements with the state and less administrative paperwork and records that burden formal corporate structures.
Pass-through Taxation
For the purpose of Federal taxation, LLCs are considered pass-through entities. Much like a sole-proprietorship, when an LLC has a single member, all of the income and losses for the LLC are filed on the member’s individual tax return. In the event of multiple members, the default situation for tax purposes is that each member is taxed as if they were a partner in a general partnership.
LLCs have the flexibility however, to choose to be taxed differently. Assuming that they would qualify as one, an LLC may also elect to be taxed as an S-corp, or C-corp.
Limited Liability
LLCs also carry the protection of limited liability. From an asset protection point of view this is the most significant benefit that an LLC offers.
In general partnerships each partner is personally liable for all of the debts incurred by the corporation. Any debt that may be established by a creditor, or other person or entity suing the partnership is borne by each partner based on their partnership interest. If all of the assets of the partnership are extinguished, the personal property of the partners may be seized to satisfy any remaining debts owed by the partnership.
The limited liability provided by an LLC does away with almost all the personal liability of its members. The debts incurred by the LLC can only be paid by the assets of the LLC; the personal assets of the members will be protected from creditors. The only case in which a member’s personal assets may be seized by a creditor are in the case of his or her own personal negligence.
For example, if a member of the LLC personally commits a negligent act while performing the business of the LLC, and is sued as a result, then the assets of the LLC as well as that member’s personal assets may be used to satisfy the debts that accrue as a result of the negligent act. The reason is that the member will be personally named as a defendant in the lawsuit. The LLC will likely be named as a co-defendant. In these instances the protection of limited liability will still shield the personal assets of the other members of the LLC. Examples in which an LLC member’s personal assets would be shielded from creditors are if an employee of the LLC who is not a member (not an owner) commits a negligent act, the members’ (owners’) personal assets would be safe - or, if one member commits a negligent act, the personal assets of the other owners will be safe.
Limited liability companies are a powerful and relatively new form of business entity. They grant members both a significant amount of management flexibility and the strong personal asset protection of limited liability. They are, however, one of many options one has when establishing a new business. As always, it is best to consult with a licensed attorney to help review your options and choose the best structure based on your personal and business needs. Call us today so we may assist you in establishing your new LLC.