– question

Reading: Limited Liability Entities

LEARNING OBJECTIVES

1. Learn about the development of limited liability entities.
2. Explore how limited liability entities are created.
3. Understand why limited liability entities are now heavily favored.

By now you should understand how easy yet dangerous it is to do business as a sole

proprietor, and why many business organizations are drawn to the corporation as a form

for doing business. As flexible as the corporation is, however, it is probably best suited

for larger businesses. Annual meeting requirements, the need for directors and officers,

and the unattractive taxation features make corporations unwieldy and expensive for

smaller businesses. A form of business organization that provides the ease and

simplicity of sole proprietorships, but the limited liability of corporations, would be much

better suited for a wide range of business operations.

A limited liability company (LLC) is a good solution to this problem. LLCs are a “hybrid”

form of business organization that offer the limited liability feature of corporations but

the tax benefits of partnerships. Owners of LLCs are called members. Just like a sole

proprietorship, it is possible to create an LLC with only one member. LLC members can

be real persons or they can be other LLCs, corporations, or partnerships. Compared to

limited partnerships, LLC members can participate in day-to-day management of the

business. Compared to S corporations, LLC members can be other corporations or

partnerships, are not restricted in number, and may be residents of other countries.

Taxation of LLCs is very flexible. Essentially, every tax year the LLC can choose how it

wishes to be taxed. It may want to be taxed as a corporation, for example, and pay

corporate income tax on net income. Or it may choose instead to have income “flow

through” the corporate form to the member-shareholders, who then pay personal

income tax just as in a partnership. Sophisticated tax planning becomes possible with

LLCs because tax treatment can vary by year.

LLCs are formed by filing the articles of organization with the state agency charged with

chartering business entities, typically the Secretary of State. Starting an LLC is often

easier than starting a corporation. In fact, you might be startled at how easy it is to start

an LLC; typical LLC statutes require only the name of the LLC and the contact

information for the LLC’s legal agent (in case someone decides to file a lawsuit against

the LLC). In most states, forming an LLC can be done by any competent business

professional without any legal assistance, for minimal time and cost. Unlike

corporations, there is no requirement for an LLC to issue stock certificates, maintain

annual filings, elect a board of directors, hold shareholder meetings, appoint officers, or

engage in any regular maintenance of the entity. Most states require LLCs to have the

letters “LLC” or words “Limited Liability Company” in the official business name. Of

course, LLCs can also file d.b.a. filings to assume another name.

Although the articles of organization are all that is necessary to start an LLC, it is

advisable for the LLC members to enter into a written LLC operating agreement. The

operating agreement typically sets forth how the business will be managed and

operated. It may also contain a buy/sell agreement just like a partnership agreement.

The operating agreement allows members to run their LLCs any way they wish to, but it

can also be a trap for the unwary. LLC law is relatively new compared to corporation

law, so the absence of an operating agreement can make it very difficult to resolve

disputes among members.

LLCs are not without disadvantages. Since they are a separate legal entity from their

members, members must take care to interact with LLCs at arm’s length, because the

risk of piercing the veil exists with LLCs as much as it does with corporations.

Fundraising for an LLC can be as difficult as it is for a sole proprietorship, especially in

the early stages of an LLC’s business operations. Most lenders require LLC members to

personally guarantee any loans the LLC may take out. Finally, LLCs are not the right

form for taking a company public and selling stock. Fortunately, it is not difficult to

convert an LLC into a corporation, so many start-up business begin as LLCs and

eventually convert into corporations prior to their initial public offering (IPO).

A related entity to the LLC is the limited liability partnership, or LLP. Be careful not to

confuse limited liability partnerships with limited partnerships. LLPs are just like LLCs

but are designed for professionals who do business as partners. They allow the

partnership to pass through income for tax purposes, but retain limited liability for all

partners. LLPs are especially popular with doctors, architects, accountants, and

lawyers. Most of the major accounting firms have now converted their corporate forms

into LLPs.

KEY TAKEAWAYS

The limited liability company (LLC) represents a new trend toward business

organization. It allows owners, called members, to have limited liability just like

corporations. Unlike corporations, however, LLCs can avoid double taxation by

choosing to be taxed like a partnership or sole proprietorship. Unless a business wishes

to become publicly traded on a stock exchange, the LLC is probably the most flexible,

most affordable, and most compatible form for doing business today. The limited liability

partnership (LLP) is similar to the LLC, except it is designed for professionals such as

accountants or lawyers who do business as partners.

and the Legal and Ethical Environment, Chapter 11.4. ​Authored by​: Terence Lau and Lisa

Johnson. ​Located at​:

http://2012books.lardbucket.org/books/business-and-the-legal-and-ethical-environment/index.html​.

License​: ​CC BY-NC-SA: Attribution-NonCommercial-ShareAlike

http://2012books.lardbucket.org/books/business-and-the-legal-and-ethical-environment/index.html

https://creativecommons.org/licenses/by-nc-sa/4.0/