The Benefits of Forming a Limited Liability Company

A limited liability company (LLC) is a type of business structure which falls halfway between a corporation and a sole proprietorship (or partnership, if there is more than a single owner). Although it is considered a business entity, it is actually a type of unincorporated association which may be set up either for profit or on a not-for-profit basis. Those who have shares in the LLC are called members.

An LLC offers the benefit of limited personal liability, similar to a corporation. This protects the membership of an LLC from the debts and acts of the LLC. However, an LLC’s limited personal liability should not be confused with full protection from personal liability. If fraud or other misrepresentation is suspected, one or more members of an LLC can still be held personally liable.

Because the Internal Revenue Service does not recognize the LLC as a taxable organization, the membership of the LLC can choose for it to be taxed as a sole proprietor, partnership, S corporation, or C corporation. This allows a great deal of tax flexibility. However, the limited liability company must qualify for the requested tax treatment.

An LLC is treated as a flow-through entity with flow-through income taxation, unless its membership opts for it to be taxed as a C corporation. In other words, profits made by most LLCs are taxed solely on the basis of shares of income allocated to its membership. This is reported only on the member(s)’ own individual tax returns, without a separate tax return for the LLC. This can result in significant tax savings over an otherwise similar corporation, where income is taxed once at the corporate level and again when paid out as individual salaries.

As an unincorporated association, the operating structure of an LLC is usually more flexible than that of a corporation, especially if the LLC only has a single member. Some states allow an LLC to be set up with only a single natural person involved. Others do not. LLCs are covered by state law, not federal law, so the exact rules for setting up and operating an LLC differ from state to state.

An LLC does not require a board of directors, although it can have a similar management structure if desired. Most states also do not require LLCs to hold annual general meetings for their membership. This cuts down on the LLC’s operating costs.

However, membership interests are treated quite similarly to various types of shares. Economic benefits can be separated from other membership interests, such as title, similar to the function of preferred stock. This allows the possibility of capital investment without diluting control of the LLC.

Once the LLC is set up, it has a limited independent existence which can last beyond the lifespan of its member(s). The extent of that independence depends on the state. In most states, the LLC exists independently of its membership, which allows control of an LLC to be passed from person to person without any need to restructure the company. However, Washington D.C. and a few states do tie the structure of an LLC to its existing membership.

Although an LLC provides many benefits to its membership, not all companies can be restructured as LLCs. For example, financial institutions such as insurance companies and banks are not allowed to become LLCs. Individual state laws governing LLCs are subject to the Revised Uniform Limited Liability Company Act (1995, revised 2006).