Definition of a Limited Liability Company
A business structure is the form a business takes, with characteristics addressing legal liability and tax considerations. These forms include sole proprietorship, partnership, corporation, and LLC. The business structure carries legal, tax, and organizational behavior implications, so the choice of business structure is a fundamental company decision. A sole proprietorship is an unincorporated business that is owned by a single individual. A partnership is a legal entity in which two or more people have joined together to own and operate a business for profit and share profits earned, losses taken, and costs paid to vendors. A corporation is a business entity formed under state incorporation statutes; corporations are separate legal persons from their owners (who are called shareholders). The federal government uses the Internal Revenue Code (IRC), which details all federal tax laws, including defining the scope and nature of corporations and their taxation. There are two types of corporations. A C corporation is a business entity, formed under state incorporation statutes, that has separate status from its owners both legally and for federal and state tax purposes. An S corporation is a business entity incorporated under a state law but treated like a partnership for tax purposes, thus avoiding double taxation.
Liability is the legal and financial responsibility of an individual or an organization for a particular wrongdoing or act. Someone who has limited liability has entered into an agreement in which the owners of the corporation are not legally responsible for the debts and liabilities of the corporation beyond what they have invested in the corporation. The liability is capped at the amount of investment. Without limited liability, many people and companies would hesitate to invest in any but the safest business deals. They would be concerned that if the company went bankrupt, creditors would demand that they give up their savings and property to pay the company's bills, even if those assets were not part of their investment into the business. However, limited liability does not mean no liability. Those who have limited liability still have some responsibility for how their company does business, and the business itself is fully liable for everything up to the extent of its assets.
A limited liability company (LLC) is a business entity that offers limited liability from or akin to a corporation and the tax status of a flow-through entity. A flow-through entity is a business structure in which the revenue stays in the business and only the partners or members are taxed on the revenue. It is considered a hybrid organizational structure of partnerships and corporations. A flow-through setup allows investors to avoid double taxation because the LLC does not pay taxes—its investors do.
An LLC is similar to an S corporation but has fewer restrictions associated with its ownership rights and communication requirements. A member of an LLC—in other words, an individual or group that has partial ownership in the LLC—risks only their investment in the company and is not personally liable for the debts of the company. The formation of an LLC is simple and requires only the articles of organization and a filing fee. These are documents created and recorded for the opening of the company; the documents must be filed with the secretary of state for the state in which the LLC is created. Limited liability company and limited liability partnership business structures are created at the state level, but the federal government does not recognize them. Instead, it sees them as a form of partnership for tax purposes.
Operating agreements are not required for LLCs, but each LLC should have an operating agreement that outlines the rights and responsibilities of its members. In cases of a dispute between members, this agreement will help determine if each member is truly acting in service of the LLC, since it should enumerate the roles of each member.
S corporations are stricter than LLCs in terms of who may hold stock in the entity. Only individual U.S. citizens or residents, a few types of trusts, and a few types of nonprofit organizations can become stockholders in an S corporation. Unlike S corporations, LLCs can have members that are corporations, partnerships, or nonresident aliens. According to the IRS, a nonresident alien is someone who is not a U.S. citizen or U.S. national and does not have a green card and is therefore not subject to U.S. taxation on the basis of residency.
Makeup of a Limited Liability Company
Limited liability companies are made up of members. An LLC that has only one member is called a single-member LLC. An LLC that has more than one member is called a multiple-member LLC. There are very few restrictions on membership in an LLC. The only restriction is that the member must be 18 or older so that the member has the ability to make binding legal agreements as an adult. Under contract law, a member who is under age 18 cannot be held legally responsible for contracts they sign.
The members of LLCs can be individuals, holding companies, S corporations, C corporations, pension plans, or most other legally recognized organizational structures. Unlike S corporations, LLCs may have foreign people and entities as members. The specifics of membership depend on individual state requirements. For example, some states require the LLC to identify individual members, while others do not.
Typically, LLCs use an operating agreement to lay out the specifics of membership and management for the company. Similar to the bylaws for a corporation, an operating agreement is the documentation of the guidelines for the internal functioning of the LLC. As a contract that members agree to in order to run the company, operating agreements are almost always used, though they are not required by law.Because LLCs are organized around a central vision or task, the operating agreement may limit the direction in which the company can move. For example, suppose AllHealth LLC is composed of Dr. Mary, an individual; HealthCare Associates, a partnership; Pills Inc., an S corporation; and FirstFloor Doctors, an LLC. AllHealth is committed to creating health care systems for underserved populations. Its operating agreement limits membership to health care providers only. It also dictates that the business make a 15 percent profit at most, with any additional profit going to a nonprofit for underserved children. Because all of the members of AllHealth hold some form of professional license in the health care field, AllHealth could be registered as a professional limited liability company (PLLC), a special form of limited liability company in which all members hold a specific professional license or credential. Several states now recognize the PLLC as a form of business entity. This form of business is popular with medical firms and legal businesses.
Sample Operating Agreement
Creating a Limited Liability Company
Limited liability companies are business structures that are allowed by state statutes, and the statutes vary from state to state. Because of this, there is no uniform rule for how to create an LLC. Therefore, the first step in creating an LLC (or a corporation of any kind) is to choose the state in which it will be formed.
Currently, all the states in the United States have statutes that allow for the formation of an LLC. Only some states allow for the formation of a professional LLC, which is one in which all members hold some form of professional license. Many LLCs choose to register in their home state because registering there is convenient. Others choose Delaware, Nevada, or Wyoming because those states' LLC rules are often considered advantageous for businesses. For example, Delaware has freedom of contract rights and a specialized court system for businesses.
Once the state of registry is chosen, the founding members must decide on a name. The name cannot be the same as another LLC's. The name must indicate that the company is an LLC. This is generally done by adding Ltd. Liability Co. or the initials LLC or L.L.C. to the name.
The LLC's name cannot include prohibited or misleading parts. For example, AllHealth could not call itself AllHealth and Bank because it does not do banking. Likewise, it could not be called AllHealth CPA since a CPA is a specific form of licensure for certified public accountants and none of the members qualify. Some states require that the name be published in a newspaper for public review.
Once the name is selected, the members write the articles of organization. Articles of organization are a document created and recorded for the opening of a company. The requirements for these articles vary from state to state but generally require the name of the company, an address, and a registered agent for the purposes of legal deliveries. Some states require a listing of all of the members, but others require a list of managing members only. The members deliver these articles to the state, generally through the secretary of state, along with a filing fee. Some states, such as California, New York, Missouri, Maine, and Delaware, require the creation of an operating agreement along with the articles of organization. The operating agreement provides the guidelines for how the organization will function.To increase regulatory oversight of LLCs throughout the United States, in 1996 the National Conference of Commissioners on Uniform State Laws proposed the Uniform Limited Liability Company Act, a set of standards for the regulation of limited ability companies to be voluntarily adopted by states. As of 2018, eight states and Washington, D.C. have voluntarily adopted this legislation.