The Limited Liability Company (LLC): An Overview

The limited liability company (LLC) is a hybrid type of business structure. A limited liability company consists of one or more owners (called “members”) who actively manage the company’s business affairs.

It contains elements of both a traditional partnership and a corporation, offering the liability protection of a corporation, with the tax structure of a sole proprietorship (if it has only one member) or a partnership (if it has two or more members).

Disadvantages

One of the most significant drawbacks to the limited liability company is the fact that it is a new type of business entity. There are not many court decisions defining the various aspects of the LLC, so members must be aware that the courts may interpret some feature in a way that is unfavorable.

In California, an LLC is prohibited from rendering “professional services,” which includes any type of services “that may be lawfully rendered only pursuant to a license, certification, or registration.” If your business is required to be licensed, registered or certified, you should check with the appropriate licensing authority to before forming an LLC.

Limited liability companies are, generally, a more complex form of business operation than either the sole proprietorship or the general partnership. They are subject to more paperwork requirements than a simple partnership but somewhat less than a corporation.

In California, LLCs are subject to filing fees for the initial formation (currently $70), and annual information statements filed with the Secretary of State (currently $20).

Although the limited liability company is a pass-through entity for federal tax purposes, LLCs are subject to state taxes which, in California, can be quite steep. In addition to the annual LLC tax of $800, the state also assess a fee based on the gross income of the LLC. This fee is not based on the profitability of the company, rather it is based solely on the revenue. Therefore, it is possible to lose money and still owe the fee.

If you are considering this type of business entity, you are strongly urged to speak with a tax professional to determine whether it is the best option for your specific situation.

Advantages

LLC members will share in the potential profits and in the tax deductions of the limited liability company, but in fewer of the financial risks involved.

Because the IRS treats the limited liability company is a pass-through entity, the profits and losses of the company pass directly to each member and are taxed only at the individual level (which may or may not be an advantage to you, depending on the profitability of the LLC and your personal income tax bracket).

Members of an LLC are permitted to be flexible in dividing the profits and losses. In a corporation or partnership, profits must be divided according to percentage of ownership.
However, with an LLC, special allocations are permitted, so long as they have a “substantial economic effect” (e.g. they must be based upon legitimate economic circumstances, and may not be used to simply reduce one member’s tax liability).

LLCs offer a relatively flexible management structure. The business may be managed either by members or by managers. Thus, depending on needs or desires, the limited liability company can be a hands-on, owner-managed company or a relatively hands-off operation for its members where hired managers actually operate the company.

LLC members enjoy a limited liability, similar to that of a shareholder in a corporation. In general, your risk is limited to the amount of your investment in the limited liability company. Since none of the members will have personal liability and may not necessarily be required to personally perform any tasks of management, it is easier to attract investors to the limited liability company form of business than to a general partnership.

Red Sky Legal can help you form your LLC; whether you need your LLC Articles of Organization, LLC Operating Agreement, or federal tax ID number (or all three), we can help. Contact us to learn how affordable - and easy - it is to protect yourself and your business.