What Are Limited Liability Companies?
A limited liability company ("LLC") is an unincorporated entity which limits the liability of its owners (generally known as members) and the persons who run it (generally known as managers) to their investments in the enterprise. The concept of LLCs continues to evolve. All 50 states and the District of Columbia have enacted LLC legislation which varies widely from state to state. New state developments occur almost daily. An LLC is sometimes described as, and is perhaps best analogized to, a limited partnership with no general partner. Like all generalizations, this one should not be pushed too far.
Why Are Limited Liability Companies Attractive?
The existence of LLCs is driven by both tax and business considerations.
Flow Through Tax Treatment. The goal is to have an entity which has the corporate characteristic of limited liability and which has flow through tax characteristics, such that income is taxed only once, i.e. at the owner level, not twice, as is the case with regular corporations, at both corporate level and owner level.
Advantages over S Corporations. LLCs are in large measure a response to limitations on the availability of S Corporations:
- LLCs are not limited, like S corporations, to one class of shareholder.
- LLCs are not limited, like S corporations, to U.S. individuals, estates certain trusts and certain entities as shareholders.
- LLCs can have preferred interests and participating debt.
- LLCs are not limited, like S corporations, to 75 shareholders.
- LLCs have flexibility in allocations, unless the strict ratable daily inclusion methodology of S corporations.
It is questionable if there would be a need for LLCs if Subchapter S corporations truly were taxed like partnerships and could operate with the flexibility of partnerships.
Avoid Partnership Stigma. LLCs avoid the "stigma" associated with partnerships because of the collapse of the real estate syndication industry after the 1986 Tax Reform Act that created the Internal Revenue Code of 1986.
Relative Simplicity. LLCs are simpler to organize than traditional limited partnerships, particularly those with corporate general partners.
What Are The Principal Characteristics of Limited Liability Companies?
Limited Liability. LLCs limit the liability of their members and managers, similar to the method by which corporate shareholders and officers have limited liability.
Non-corporate Nature. LLCs are not subject to restrictions on finance and management. There is no obligation to pay dividends or requirement that management be by a board of directors. In this regard they are more similar to partnerships.
Participation and Control. Most LLC statutes permit management directly by the members without loss of limited liability. Alternatively, the entities may provide for centralized management by persons designated as managers by agreement.
Who Will Use LLC's?
Prime candidates include:
- Real estate ownership entities.
- Entities which would otherwise operate as S corporations but cannot qualify (e.g., those with foreign investors, corporate or trust investors, or holders of preferred stock).
- Technology joint ventures and research and development entities.
- Health care entities (MSOs, IPAs, etc.) which need flexibility and flow through tax treatment.
- Closely held investment and hedge funds.
- Start-up entities with venture capital financing.
- Closely held family businesses that need flexibility in operation.
- Professional firms.