Limited Liability Corporation

The LLC is the newest of the forms of business entity, and as a result there are some unanswered questions concerning its use. All states now have enacted LLC statutes which provide that members of an entity incorporating under that state statute will not be personally liable for the debts of the entity. The entity will be treated as a partnership for federal, and generally state, tax purposes unless the entity elects taxation as a corporation.

The biggest advantage of an LLC is its flexibility. LLCs are hybrid entities that combine the flow-through attributes of partnerships with the corporate characteristic of limited liability. Therefore, like a corporation, the LLC offers limited liability to its members. Members of an LLC are only at risk to the extent of their investment and cannot be sued for the actions of the LLC. The maximum amount a member can lose is the value of his investment in the LLC. His personal assets are protected.

Like general partners in a partnership, LLC members may participate in the management of the LLC. However, unlike limited partners, participation in management will not cause the member to lose his limited liability protection.

Unlike a corporation, an LLC is not subject to two levels of tax. Income or loss from the LLC flows from the LLC to the members and is recorded on the members’ individual returns. The LLC operating agreement can provide for an allocation of most items of income and deduction in any manner in which the members see fit. The LLC is, however, required to file a partnership return.

LLCs are similar to S corporations in that they provide limited liability for owners, but are not subject to tax at the corporate level. However, unlike S corporations, an LLC is not subject to any limitation on the number and type of members it may have. In addition, the one class of stock restrictions and the complex regulations governing S corporation status do not apply to LLCs, thereby allowing flexibility in planning distributions and special allocations. The LLC operating agreement can provide for special allocation of most items of income and deduction.

An LLC is created by filing articles of organization with the state in which it is incorporating. Thus, certain filing fees will be incurred. Although an operating agreement is not required, it is an important document for setting forth the members’ understanding of the procedures and formula for distributing profits and losses, as well as various other operational concerns.

Generally, a domestic entity with more than one member that is formed as an LLC, will default to partnership entity classification and nothing is required on the taxpayer’s part to ensure such classification.

The main drawback to forming an LLC is the limited guidance available concerning their use. Because they are relatively new, there is limited case law and few IRS rulings and procedures to guide taxpayers as to the consequences of certain transactions. Most of the uncertainty stems from the fact that members of an LLC are not designated as limited or general partners as they are in a partnership. Therefore, it is unclear how various statutes which govern the consequences of limited partners versus general partners apply to LLC members.

In determining whether the LLC is the best choice of entity for operating your business, the advantages of limited liability and pass-through treatment must be carefully weighed against the disadvantages of the uncertainties which exist surrounding this type of entity. Only an overall examination of your objectives and the requirements of your business will yield the answer as to whether this is the best entity to use when starting your business.