Saturday, December 10, 2011

Incorporation 101: The Nature of Limited Liability Companies

What is LLC?

Limited Liability Company (LLC) is a relatively new business structure allowed by state statute. It is neither a partnership nor a corporation, but a distinct type of business structure that offers an alternative to those two traditional structures by combining the corporate advantages of limited liability with the partnership advantage of pass-through taxation.

Limited Liability Companies are becoming more and more popular, and it's easy to see why. LLCs combine the personal liability protection of a corporation with the tax benefits and simplicity of a partnership. In addition, they're more flexible and require less on going paperwork than corporations.

Owners of an LLC are called "members". Since most states do not restrict ownership, members may be individuals, corporations, and other LLCs and foreign entities. There may be unlimited number of members. Most states also permit "single member" LLCs, those having only one owner.

Members in an LLC are analogous to partners in a partnership or shareholders in a corporation, depending on how the LLC is managed. A member will more closely resemble shareholders if the LLC utilizes a manager or managers, because then the members will not participate in management. If the LLC does not utilize managers, then the members will closely resemble partners because they will have a direct say in the decision-making of the company.

Why Should I Form an LLC?

If you decided to start your own business, you will need to figure out which type of business entity you want to set up. Today LLC is one of the most popular business entities established by new businesses because of the many advantages it has. Forming an LLC helps protect your personal assets, reduces your taxes and saves your time and efforts by eliminating excessive paperwork. In other words, LLCs are often favored over other types of business entities because they combine the limited liability protection of a corporation and the pass through taxation of a partnership.

Single- vs. Multiple-Member LLC

In general, LLCs can be formed with unlimited numbers of members, in which case it is called Multiple-Member LLC. Nevertheless, most states also permit Single-Member LLCs, having only one owner (member). A Single-Member LLC is taxed as a sole proprietorship, while a Multiple-Member LLC is taxed as a partnership.

Advantages of Forming LLC

LLC is a relatively new type of business structure that combines the best features of the corporation with those of the sole proprietorship or partnership. LLC has many advantages and benefits which cannot be enjoyed together in any other type of business.

  • Personal Liability Protection:
LLC is an entity separate from its owner(s). Being legally distinct entity, the personal assets of the owner (such as personal residences, and personal bank accounts) are not reachable by business creditors. The LLC owner's liability is generally limited to the amount of money that person has invested in the LLC. Thus, LLC members are offered the same limited liability protection as corporation's shareholders.
  • Tax Advantage:
LLCs allow pass-through taxation, and that advantage is the prime reason for the recent popularity of the LLCs. Pass-through taxation means that earnings of an LLC are taxed only once, basically being treated like the earnings from a partnership, sole proprietorships and most S-Corporations.
  • Ease of Transfer:
With LLCs its easier to sell ownership interests to third parties without disrupting the continued operation of the business. As a comparison, selling interests in a sole proprietorship or general partnership require much more time and effort. An owner must individually transfer assets, business licenses, bank accounts, permits and other legal documentation.
  • No Ownership Restrictions:
LLCs have no restriction on the number or types of owners. By comparison, S-Corporations cannot have more than 100 stockholders, and each must be a resident or citizen of the United States. None of these restrictions apply to an LLC.
  • Easier to Raise Capital:
LLCs allow for many ways to raise capital. You can admit new members by selling membership interests. You can even create new classes of membership interests with different voting or profit characteristics.
  • Greater Credibility:
As a registered LLC, your business will enjoy legitimacy and greater credibility when dealing with other companies, banks and potential partners/investors.
  • Flexible Management and Ownership Structure:
Like general partnerships, LLCs are generally free to establish any organizational structure agreed on by the members. Thus, profit interests may be separated from voting interests.

How to Form an LLC?

After you decide to form an LLC, Articles of Organization must be filed with that state and initial fees must be paid. After your Articles of Organization are filed, your LLC should have an organizational meeting where an Operating Agreement is adopted, interest certificates are distributed, and other preliminary matters are completed. LLC Kit includes all of the information and paperwork to make this process easier.
  • Publications:
Three states require notice to be published in a newspaper that an LLC has been formed - New York, Arizona and Nebraska.
  • Federal Tax ID Number:
A Federal Tax Identification Number, also known as an Employer Identification Number or EIN, is basically a social security number for businesses. It is the number the IRS uses to identify the business, and it must be included on tax filings the business makes. If you operate your business as a sole proprietorship or partnership and are now looking to incorporate or form an LLC, you must obtain a new EIN for your business.
  • Single-Member LLCs:
The IRS does allow Single-Member LLCs to qualify for pass-through tax treatment. However, taxation of one person LLCs at the state level may be different.
Corporation as an LLC Member

A corporation can be a member of an LLC. This allows you to create an additional level of ownership, which is designed to create an entity that can offer such traditional fringe benefits as retirement plans and an additional level of protection from liability.

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