A limited liability company (LLC) is a hybrid of a partnership and a corporation. The main benefit is, as the name suggests, limiting liability of the owners. This is a property they share with corporations. The other advantage is that profits are taxed as personal income, and this is usually lower than what corporations pay.
Starting an LLC
The general rule is that an LLC can have at most, two of the four attributes of a corporation:
A. Liability limited to company assets.
B. Centralized management.
C. Free transfer of ownership.
D. Unlimited lifespan.
Since A and B are the most attractive, most LLCs have restrictions on C and D. So an LLC may have, for instance, a limited lifespan and require renewal periodically.
Just like a corporation a legal name must be created and searched. States may require the initials ‘LLC’ appear in the name. An operating agreement and articles of organization must be drawn up and filed. Documents are filed with the Secretary of State, as well as Federal and Local governments.
Of interest to small business owners is the Single-member LLC, which has a single owner. Recordkeeping and structure for an LLC/SLLC are more complicated than for a partnership, but less than for a corporation.
An LLC is not separate from its owners for taxes. This means that there is no corporate tax burden. Profits flow through to the owners and are taxed at the personal income tax rate. The LLC does file a yearly form with the IRS, but it is for informational purposes only. It is used by the IRS to determine if the owners are paying the correct amount of personal income tax.
An LLC has the same protections a corporation does. But because the separation of ownership isn't as great in an LLC, there are a couple of traps. Personal liability can result from:
- Causing an injury or acting negligent. This would have to be a personal and direct
result of actions the owner takes.
- Personally guaranteeing a loan or credit agreement. This is true for corporations as
well. Participants must be careful to act in the business name instead of their own name.
- Misfiles or doesn’t file wage and related taxes. The LLC ‘shield’ can be pierced by the IRS.
- Intentionally doing something illegal.
- Failing to keep personal and LLC separate. In this circumstance, if it can be shown that someone was mixing finances and resources, the LLC can be voided by a court.
The last on that list is particularly important. Comingling occurs when personal and business matters are mixed together. Using company money or inventory outside of the company is a common mistake. If someone can demonstrate this, the LLC shield can be revoked.
LLC Credit and Financing
Stock is not sold in an LLC arrangement. Financing parallels sole ownership or partnership structures. Financing may be easier to obtain simply because the LLC is a formal legal entity with known assets and obligations.
In many states, when one member of an LLC leaves, the company must be dissolved. This can be addressed in the formation agreement with terms relating to buy-out. Otherwise, all debts and accounts must be settled. After that, the LLC can be reformed with the remaining partners if desired.