Limited Liability Companies – LLC

Photo of LLC agreementWhat is a Limited Liability Company?

Established by state law,  a Limited Liability Company, (commonly referred to as an “LLC”),  is a form of business organization that is similar in form to a sole proprietorship or partnership, (simple to own and operate), but possesses a limited liability “shield” that protects its owner(s) from liability to the same extent that stockholders of a corporation are insulated from its debts and obligations.[1]

What does Limited Liability Actually Mean?

For the owner of an LLC or the corporate shareholder,  limited liability means that you are not personally liable for the debts and obligations of the company.[2]   Practically speaking,  limited liability refers to the ability of an LLC owner or corporate shareholder to risk only the capital, (money, property, materials, equipment etc.) that such individual actually invests in the company.[3]  Under the “shield” of limited liability, the risk of company debts and liabilities does not extend to the LLC owner personally.

Why Should I Form an LLC?

  1. Liability Protection – By far,  the most commonly cited reason for forming an LLC is the limited liability protection offered by the entity.  Those persons currently doing business as a sole proprietorship or in a partnership should seriously consider setting up an LLC to take advantage of the liability protection.

We live in a litigious society, so business owners need to take advantage of all risk-management tools that are available, especially when they come at an affordable cost.[4]  If someone gets seriously injured at your place of business, in your rental property, or by your employee, there is a decent chance that you will be sued.  The risk of losing everything can make the idea of starting a new business seem disproportionately hazardous in comparison to the anticipated rewards.  An LLC is an effective way to get liability protection for sole proprietorships and partnerships.
  2. Asset Protection – Similar to the way that a business owner could use an LLC to protect him/herself from the liabilities of the company,  so too can the business owner protect certain valuable assets from the liabilities of another asset or activity.  

For example, many companies choose to place operating assets (such as a backhoe and/or dump truck) in a leasing company and then lease those assets to the operating company.  This would allow a construction company to separate the valuable operating equipment from the liabilities of the construction business.   

For those who own rental properties,  the equity of one property should in some cases be protected from the potential liabilities of another property.  By placing separate properties in separate LLC’s,  an owner can protect a valuable property from the liabilities of another property, while maintaining full ownership and control of both.

In the case of a hotel operator or bed and breakfast,  the restaurant activities may be placed in a separate LLC from the hotel.  This will allow the business owners to separate the liability concerns of the restaurant from that of the hotel.
  3. Formalities and Administrative Costs –  There are varying levels of formality and administrative costs associated with forming and operating the different business entities.  The sole proprietorship and partnership are the simplest and most inexpensive form of business entity,  but they do not offer the business owner any protection from liability.  For limited liability,  the business owner should consider an LLC or corporation.  When compared to the corporation,  the LLC is easier and more cost-effective to own and operate.  LLC’s are not saddled with all the formalities of the antiquated corporation,  such as the requirement of keeping minutes,  having annual meetings,  and electing directors and officers.  In addition,  there are generally more state and local tax filing requirements for corporations,  and corporations will need to worry about payroll tax reporting for business owners taking a salary from the corporation.[5]

What are the Other Main Alternatives ?  

  1. Sole Proprietorship
  2. General Partnership
  3. Limited Partnership
  4. Corporation
  5. Subchapter “S” Corporation

Give us a call to discuss the particular advantages and disadvantages of each type of business entity.  As a general rule,  with a few limited exceptions, the small business owner of today will find that the Limited Liability Company (LLC) provides the best alternative for forming their business (or converting their old sole proprietorship or partnership to obtain limited liability).

How are LLC’s taxed?

Under the IRS “check-the-box” regulations,  taxation of LLC’s has been greatly simplified.  The regulations allow the business owners of any eligible entity to elect the desired classification status for federal tax purposes.[6]   Generally speaking,  a one-person LLC may elect to be taxed as a sole proprietorship, a C corporation, or as a subchapter S corporation.[7]  A multi-person LLC may elect to be taxed as a partnership, a C corporation or as a subchapter S corporation.[8]  Under the IRS default provisions,  if no special election is made,  a one-person LLC will be taxed as a sole proprietorship,  and a multi-person LLC will be taxed as a partnership.[9]   You should consult with your Accountant,  in conjunction with your Attorney,  to determine which tax treatment will be best for your particular business.

[1] Harry L. Henning & Richard C. McQuown,  Ohio Limited Liability Company, Forms and Practice Manual,  § 1.3 (2002).

[2] Robert B. Thompson,  The Limits of Liability in the New Limited Liability Entities,  32 Wake Forest L. Rev. 1, 7 (1997).

[3] Rebecca J. Huss,  Revamping Veil Piercing for All Limited Liability Entities: Forcing the Common Law Doctrine into the Statutory Age,   70 U. Cin. L. Rev. 95, 96 (2001).

[4] Bruce D. Bernard and Thomas J. Sigmund,  Selecting the Form of Business Entity:  Analyzing LLC’s and Other Entity Choices, § 9.2  (2003).

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