By: Zachary Brown
A limited liability company, commonly referred to as an “LLC”, is a type of business entity that has become popular in the United States because of some of the benefits it provides to business owners. This article shall serve as an overview of the LLC, what it is, its advantages, and some disadvantages. Hopefully this article will show why so business owners have elected to start a business using this type of entity.
An LLC is a business entity that is owned by its members and governed by an operating agreement. A typical operating agreement will, at a minimum, determine how the LLC is organized, how it is to be managed, the financial distributions of the LLC, and how the LLC may be dissolved.
An LLC shares advantageous traits of other business entities. For example, LLCs share an advantageous trait with corporations – limited liability. Limited liability means that a member’s liability is almost always limited to that member’s investment in the LLC. The result of this, except in rare circumstances, is that a member’s personal assets are not at risk if the LLC is sued or goes bankrupt.
LLCs also share an advantageous trait with other types of entities in the way it elects to be taxed. The LLC will elect how it wishes to be taxed for federal tax purposes. Subject to the number of members, the LLC may elect to be taxed as a sole proprietorship, partnership, S corporation, or C corporation. If the members elect to be taxed as a sole proprietorship, partnership, or S corporation, they are usually considered a “pass-through” entity. That means the income will be taxed at the individual level on the member’s personal tax return. This allows an LLC to avoid the double taxation incurred by a C-corporation (a common form of corporation) which are taxed first at the corporate level, then again at the individual level.
In addition to certain tax benefits and limited liability, there several other advantages associated with forming an LLC. The LLC is controlled by an operating agreement rather than bylaws, so typically there are no corporate minutes or resolutions, making it administratively more efficient and easier to manage. When forming LLCs, there are usually no restrictions on the number or type of members allowed (i.e. an S corporation may be a member of an LLC). Lastly, members have great flexibility in structuring the initial operating agreement governing the LLC.
There are a few notable drawbacks when selecting the LLC as a business entity. Typically, it is more difficult to transfer a member’s ownership interest in comparison to a corporation. If the LLC works with international companies, the LLC may be treated as a corporation in the countries where the LLC is doing business. The annual filing fees for LLCs are more expensive than most other business entities. Lastly, there are a number of legal complexities with LLCs, so legal issues involving tax, management, dispute resolution, and buyouts tend to arise if the operating agreement that governs the LLC is poorly drafted.
An LLC is something that a prospective business owner will want to consider when forming a business. As always, consulting with a local attorney is the best option to make sure this is the right business entity.