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Limited Liability Company: Its Time Has Almost Arrived
Why are so many businesses ready to form a Limited Liability Company (LLC) over the general partnership, the limited partnership, the S Corporation and the closely held corporation? Why not, if you can achieve the advantages of flow-through tax treatment and limited liability for owners with simplicity of structure.
Although LLCs created and used by the Germans since 1892, the first state to enact a true LLC statute was Wyoming in 1977. Virginia and Maryland both recently enacted LLC statutes as have the majority of states. However, not all such statutes are the same, leaving concerns about whether certain states will respect the tax pass-through and limited liability of LLCs from other states. Nevertheless, a Uniform LLC Act will be formulated in the near future which will resolve many of these problems.
The IRS Says "Yes"
Until 1988 when the IRS finally upheld the Wyoming statute, it was uncertain whether the LLC would be classified as a partnership for federal tax purposes. The IRS now permits partnership tax treatment of an LLC if it lacks two of four corporate characteristics, which it defines as:
- continuity of life
- centralization of management
- limited liability
- free transferability of interest
The IRS ruling encourages members of the LLC to manage the business themselves. However, a 1994 IRS regulation has caused renewed concerns for LLCs set up only for tax avoidance.
The LLC resolves the restraints of S Corporation elections, and still permits direct management which is a handicap of the Limited Partnership entity. The LLC has the flexibility of a partnership in structuring the allocation of profits, losses and distributions in differing ratios. Thus, tax benefits are achieved while the general partner is shielded from personal liability.
Formation of LLC
At its inception the LLC in Virginia files simple Articles of Organization with the State Corporation Commission. A Registered Agent is required. Existing general and limited partnerships can convert to an LLC. The Operating Agreement defines the members agreements on capitalization, voting, management, distributions, allocations and addition of new members.
Members and managers (who need not be members) are subject to statutory standards of conduct in order to be protected from liability. However, creditors can "enforce a member's right against or liability to" the LLC.
Popular Uses
Real estate investing is moving toward LLCs. In addition to the other benefits, they provide simplification of estate and multi-state problems because of the LLC's ability to hold and pass title after death or incompetency
The flexibility of forming a management and ownership structure designed for particular needs will entice many new businesses, venture capital and corporate joint ventures. Family businesses can avoid S Corporation difficulties, maintain control, yet still permit the involvement of multiple individuals.
Professionals can avoid losing their personal assets because of the negligent acts of a partner or employee. Non-American businesses have used this business form for a long period of time and in many cases would prefer it when investing in the U.S.
Conclusion
Some concerns remain, such as how to freely transfer membership interests, forced dissolution upon death or termination of a member, and recognition of the LLC by other states. Nevertheless, the LLC can be used now for activities within a single jurisdiction, especially for certain joint ventures or for real estate investing. Once lingering problems are resolved, it should replace general and limited partnerships, as well as S Corporations.
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