What is a Limited Liability Company (LLC)? An LLC a non-corporate entity that is authorized by statute and may engage in lawful acts or activity. The owners (members) have no personal liability. The obligations are solely the liability of the LLC. Members are also able to structure shares, distributions, powers, rights in almost any manner they deem fit. Many entrepreneurs will use this as the LLC needs only one member. Finally, all of the income, gains, losses, etc of the LLC are passed through to the member(s) to report on their personal income tax returns.
How is an LLC formed?
The California Revised Uniform Limited Liability Company Act (RULLCA) controls LLCs in California. According to RULLCA, an LLC is formed when the Secretary of State receives and files the LLC’s Articles of Organization.
Operating Agreements are necessary and important as they govern the activities of the LLC. While an Operating Agreement may be oral or implied, there is no better practice than to have it down in writing.
Advantages of an LLC
Prior to LLCs, Limited Partnerships and S Corporations were the primary vehicle for pass through tax treatment. The LLC now allows for that and gives some additional benefits:
A. Limited Partnerships
The largest advantage of an LLC over a Limited Partnership deals with liability. Under a Limited Partnership, at least one person (general partner) must be fully liable for the business’ obligations – even limited partners who take some control in the business may become personally liable. This is not the case with an LLC.
B. S Corporations
S Corporations also allow for the pass through of taxes, but S corporation status has limited flexibility as it is allowed only one class of stock. Additionally, items of gain, loss, income, etc, must be taken into account with the shareholder’s prorate holdings of the stock.
A few more restrictions on who can be shareholders of an S corp:
- Only U.S Citizens
- Certain trusts
- Certain tax-exempt organizations
- Should an ineligible person/entity become a shareholder, then the corporation will lose its S status and lose its tax treatment.
These are important issues to discuss with corporate counsel when deciding what type if entity to create for your business. The outcomes and risks can be enormous to the shareholders and need to be thoroughly explored.