All About Limited Liability Companies
A limited liability company (LLC) is a business entity in which the owners have limited liability for the debts of the LLC. Income and losses are passed through to the owners. This limited liability is similar to what corporations have, while the treatment of income and losses is similar to that of partnerships. These characteristics have made the limited liability company a very popular business entity. Members can include individuals, corporations, and other LLCs. In 1977, Wyoming was the first state to allow the creation of a limited liability company. Twenty years later, all fifty states allowed LLCs. Outside of the basic, multiple member limited liability company, there can also be single member LLCs and series LLCS.
Advantages
The main advantage of an LLC, which gives the entity its name, is that the liabilities of the members are limited to the amount they put into the company. They are protected from the debts of the company, much like shareholders of a corporation. Though the treatment of liabilities is similar to that of a corporation, LLCs avoid the double taxation associated with corporations. Members of an LLC are only taxed at their individual tax rates, and are not subject to the tax rates of the LLC. LLCs provide a lot of flexibility for the owners with regards to taxation. Owners can elect for the LLC to be taxed as a sole proprietorship, a partnership, an S-corporation, or a corporation. The LLC members can choose which one they prefer based on different tax rates. Members of an LLC have more power than those in a corporation because they do not have a board of directors. This allows the owners more flexibility in their decision-making. Unlike sole proprietors, LLCs do not end when the owners are ill or dead. This means that a limited liability company can last a lot longer than sole proprietors can.
Disadvantages
Though there are many advantages to forming a limited liability company, there are also distinct disadvantages. For instance, the earnings of the members of an LLC are usually subject to a self-employment tax. Earnings in an S-corporation can usually flow through to the members without this tax. The limited liability company will be terminated for federal tax purposes if at least half of the capital and profit interests are sold or exchanged within a one-year time period. If an LLC is treated as a partnership, it can’t take advantage of stock options, issue Section 1244 stock, or engage in tax-free reorganizations. Each state treats limited liability companies differently. There are some states that do not tax partnerships, but do tax LLCs. This leads to inconsistency for limited liability companies that operate in multiple states. If an existing company converts to a limited liability company and has appreciated assets, it could be forced to recognize that appreciation for tax purposes.
Types of LLCs
There are three different types of limited liability companies. The first, and most common type, is a multiple member LLC. This entity has formed by multiple members and carries the advantages and disadvantages described above. A multiple member LLC must file a partnership tax return and comply with all partnership taxation rules.
A single member LLC is a limited liability company with only one member. There was a time where limited liability companies were required to have at least two members, but today all states allow the creation of LLCs with only one member. For single member LLCs, if it is not treated as a corporation, it is disregarded for federal income tax purposes. The member must account for the income and expenses on Schedule C of his or her Form 1040. This type of limited liability company does not have to file a partnership tax return. There have been some concerns as to how limited the liability would be for a single member in this circumstance, but there appears to be no difference between a single member LLC and a multiple member LLC in terms of protection from liabilities.
The third type of limited liability company is a series LLC. This is the most recently created form of an LLC. A series limited liability company allows the company to create separate series within the LLC. These series act as sub-entities within the larger LLC. Each sub-LLC has separate assets, liabilities, profits, and losses. The assets of each sub-LLC are protected from the liabilities of the other sub-LLCs. Series LLCs are good planning tools for businesses like hedge funds and venture capital funds. There are many unresolved issues with series LLCs, including tax implications and debtor/creditor issues.
