What is a Limited Liability Company and how is it set up?
The limited liability company, LLC, is the most recent addition and popular of the choices for a new business entity. As an LLC, your business may have the flexibility of a partnership and the legal protection of a corporation. Because of its dual character of corporation protection against personal liability and partnership tax treatment, the LLC has come to replace general partnerships, limited partnerships, and S corporations as the entity of choice for small businesses. It is not, however, the choice for businesses seeking venture capital or “angel” financing. For them, a C Corp may be best permitting various classes of stock. Additionally, Massachusetts in recent years allows single member LLC’s. The LLC may need an operating agreement to define the relationship between its members, similar to a partnership agreement, to control business, financial and tax matters. The operating agreement may be oral, although it should be in writing and signed by all the LLC’s members. Management of an LLC may be vested either in the members or in certain designated “manager(s).” Managers do not have to be members of the LLC, and even corporations may serve as managers. A check-the-box form filed with the IRS by your accountant will determine whether the LLC is taxed as a partnership or corporation; but the default provision is a partnership tax treatment if no election is filed.
What are the primary advantages of an LLC that should be considered when starting a business compared with an S Corp?
LLC members are protected from personal liability just as are corporate shareholders. Since the LLC will likely be treated as a partnership as to tax treatment: it will be a flow-through entity for which income and losses are reported directly by its members on their tax returns. Unlike an S corporation, special allocations of income, expenses, deductions and losses can be made among its members, and an individual member’s losses are not limited by the amount of a member’s investment in the LLC. The LLC differs from a partnership in that management may be by nonmembers. An LLC should be used rather than an S corporation when a business plans to have foreign persons, corporations or trusts as shareholders. The LLC is also a useful entity for estate planning purposes since trusts and estates are eligible shareholders.
What are the primary disadvantages of an LLC that should be considered when starting a business?
With the LLC being a newer legal entity, there are fewer legal precedents concerning the law of LLC’s. There may be more involved in setting up an LLC, particularly when formulating an operating agreement among multiple members, than in organizing a corporation. In Massachusetts, the fee for filing an LLC with the Secretary of State is higher than the fee for filing a corporation, as is the fee for filing the annual reports. Other cost savings generally offset this disadvantage.
In what situations is the Limited Liability Company best suited?
In summary, an LLC is best used when one or more people are considering a new company. The LLC provides significant advantages over both general partnership and limited partnership structures. Similar to an S Corporation, it does not have the “S Corp’s” restrictions. LLC’s are available to professionals and may be advisable in place of a Limited Liability Partnership because more states recognize LLC’s than LLP’s for the protections discussed here. LLC’s should not be used when a “C” corporation would be able to utilize the corporate reorganization tax provisions or the ability to have separate classes of stock. C corporations are particularly appropriate for companies expecting to attract “angel investors” or venture capital which often take preferred stock.