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A limited liability company (LLC) combines attributes from both
corporations and partnerships (or for one-person LLCs, sole
proprietorships): the corporation's protection from personal
liability for business debts and the simpler tax structure of
partnerships. And while setting up an LLC is more difficult than
creating a partnership or sole proprietorship, running one is
significantly easier than running a corporation.
Number of Members
You can
form an LLC with just one person
in every state. And while there's no maximum number of owners that an LLC can have,
for practical reasons you'll probably want to keep the group small.
An LLC that's actively owned and operated by more than about five
people risks problems with maintaining good communication and
reaching consensus among the owners.
Limited Personal Liability
Like shareholders of a
corporation, all LLC owners are protected from personal liability
for business debts and claims. This means that if the business
itself can't pay a creditor -- such as a supplier, a lender or a
landlord -- the creditor cannot legally come after any LLC member's
house, car or other personal possessions. Because only LLC assets
are used to pay off business debts, LLC owners stand to lose only
the money that they've invested in the LLC. This feature is often
called "limited liability."
Exceptions to Limited Liability
While LLC owners enjoy
limited personal liability for many of their business transactions,
it is important to realize that this protection is not absolute.
This drawback is not unique to LLCs, however -- the same exceptions
apply to corporations. An LLC owner can be held personally liable if
he or she:
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personally and directly injures someone
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personally guarantees a bank loan or a business debt on which
the LLC defaults
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fails to deposit taxes withheld from employees' wages
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intentionally does something fraudulent, illegal, or clearly
wrong-headed that causes harm to the company or to someone else,
or
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treats the LLC as an extension of his or her personal affairs,
rather than as a separate legal entity.
This last exception is the most important. In some circumstances,
a court might say that the LLC doesn't really exist and find that
its owners are really doing business as individuals, who are
personally liable for their acts. To keep this from happening, make
sure you and your co-owners:
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Act fairly and legally.
Do not conceal or misrepresent
material facts or the state of your finances to vendors, creditors
or other outsiders.
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Fund your LLC adequately.
Invest enough cash into the
business so that your LLC can meet foreseeable expenses and
liabilities.
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Keep LLC and personal business separate.
Get a federal
employer identification number, open up a business-only checking
account, and keep your personal finances out of your LLC
accounting books.
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Create an operating agreement. Having a formal written
operating agreement lends credibility to your LLC's separate
existence.
Business Insurance
A good liability insurance policy
can shield your personal assets when limited liability protection
does not. For instance, if you are a massage therapist and you
accidentally injure a client's back, your liability insurance policy
should cover you. Insurance can also protect your personal assets in
the event that your limited liability status is ignored by a
court.
In addition to protecting your personal assets in such
situations, insurance can protect your corporate assets from
lawsuits and claims. Be aware, however, that commercial insurance
usually does not protect personal or corporate assets from unpaid
business debts, whether or not they're personally guaranteed.
LLC Taxes
Unlike a corporation, an
LLC is not considered separate from its owners for tax purposes.
Instead, it is what the IRS calls a "pass-through entity," like a
partnership or sole proprietorship. This means that business income
passes through the business to each LLC member, who reports his
share of profits -- or losses -- on his individual income tax
return. Each LLC member must make quarterly estimated tax payments
to the IRS.
While an LLC itself doesn't pay taxes, co-owned LLCs must file
Form 1065, an informational return, with the IRS each year. This
form, the same one that a partnership files, sets out each LLC
member's share of the LLC's profits (or losses), which the IRS
reviews to make sure the LLC members are correctly reporting their
income. You'll also want to check with the state department of
revenue for the individual state tax requirements.
LLC Management
The owners of most small LLCs
participate equally in the management of their business. This
arrangement is called "member management."
The alternative management structure -- somewhat awkwardly called
"manager management" -- means that you designate one or more owners
(or even an outsider) to take responsibility for managing the LLC.
The non-managing owners (sometimes family members who have invested
in the company) simply sit back and share in LLC profits. In a
manager-managed LLC, only the named managers get to vote on
management decisions and act as agents of the LLC. Choosing manager
management, however, can complicate securities issues for your
LLC.
Forming an LLC
To create an LLC, you begin by filing
"articles of organization" with the LLC division of your state
government. This office is often in the same department as the
corporations division, which is usually part of the Secretary of State's
office. Filing fees are typically $100 or less.
Many states supply a blank one-page form for the articles of
organization, on which you need only specify a few basic details
about your LLC, such as its name and address and contact information
for a person involved with the LLC (usually called a "registered
agent") who will receive legal papers on its behalf. Some states
also require you to list the names and addresses of the LLC
members.
In addition to filing articles of organization, you must create a
written LLC operating
agreement. While you don't have to file your operating agreement
with the state, it's a crucial document because it sets out the LLC
members' rights and responsibilities, their percentage interests in
the business and their share of the profits.
Finally, your LLC must fulfill the same local registration
requirements as any new business, such as applying for a business
license and registering a fictitious or assumed business name.
Ending an LLC
Under the laws of many states, unless
your operating agreement says otherwise, when one member wants to
leave the LLC, the company dissolves. In that case, the LLC members
must fulfill any remaining business obligations, pay off all debts,
divide any assets and profits among themselves, and then decide
whether they want to start a new LLC to continue the business with
the remaining members.
Your LLC operating agreement can prevent this kind of abrupt
ending to your business by including "buy-sell" provisions, which
set up guidelines for what will happen when one member retires,
dies, becomes disabled or leaves the LLC to pursue other
interests.
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