Defining the LLC: Benefits of a Limited Liability Company
Many Attorneys and CPAs view the Limited Liability Company (LLC) as the business form of choice for those business owners desiring 1) protection from individual liability for company debts, negligence, and breaches of contract with personal liability limited to the contribution and any personally guaranteed loans; 2) charging order protection and 3) flow through taxation, unless taxed as a Corporation.
In addition, the IRS is now allowing an LLC election to be taxed as a Subchapter S. This makes LLCs very flexible as they can now be taxed as Disregarded Entities, Partnerships, Corporations and Sub Chapter S while maintaining limited liability, charging order protection and privacy.
The LLC is a hybrid between the corporation and the limited partnership. The LLC protects all members (owners) from individual liability for company debts and misdeeds, much like the corporation. What’s more, while a creditor of the corporation can attach corporate stock and gain control of the corporation, a creditor of a LLC cannot become a member and control the company, a creditor of a LLC can only receive an income interest in the company.
In the event a Member is sued and a judgment rendered, the creditor only has an income interest of that Member. This is known as Charging Order Protection for the LLC and other Members. It is possible for the creditor to end up with no control in the company, no money if the “losing” member does not take a distribution and be liable for the Members tax liability. No control, no money and an additional tax liability is not a good position for the creditor. Therefore, Attorneys for the creditor are typically anxious to settle as it is in the best interest of their client.
Consequently, the LLC combines the best of corporations and partnerships because the LLC offers its members protection from individual liability and, like a limited partnership, allows others to become a member only if the other members unanimously agree.
The LLC natural tax default is that of a partnership or a disregarded entity in the event of only one Member. In other words, it is a flow through entity. The LLC does not pay income tax, rather income is distributed to the members according to their ownership interests and the members report the income on their individual income tax returns.
The LLC may also be taxed as a corporation so the members can enjoy certain corporate tax benefits, like retained earnings. In addition, with the proper strategy the LLC taxed as a corporation with the proper structure can offer maximum privacy.
The LLC is governed by its regulations called an operating agreement. LLC regulations are a hybrid between corporate bylaws and a partnership agreement. The LLC is further distinguished from the corporation in that it is not generally required to have annual meetings unless otherwise stated in the operating agreement. However, it is considered prudent and advisable to have at least an annual meeting to establish and maintain good records and accountability.
In addition, some states require a meeting at some interval. In order to maintain protection from individual liability, the LLC must still keep its accounting separate from its individual owners, must have good and accountable essential records, and must have and abide by company regulations in the Operating Agreement.
A List of Essential Elements in an LLC's Operating Agreement
- Initial Manager’s Filing
- Create and Accept Operating Agreement
- Manager’s Initial & Annual Meetings
- Initial & Annual Election of Officers
- Necessary Company Resolutions
- Necessary Certificates of Authority
- Initial & Annual State Filings
- Initial & Annual Penalty of Perjury Declaration
- Company Asset Encumbrance
- Membership Interest Ledger
- Selling, Merging or Dissolution
- Changes or Consolidation of Assets, Business, etc.
- Annual Notices & Proxies
- Banking Documentation and Authority