BUSINESS LAW: Limited
WHAT IS A LIMITED LIABILITY COMPANY?
A Limited Liability company is
similar to a corporation, in that it protects the owners from personal
liability for certain debts of the company, but is taxed more like
a partnership, can be owned by non US citizens and non US residents,
and may have an unlimited number of members. This article applies
only to California Limited Liability companies. Other states may
have different requirements.
A California limited liability company (LLC) is
generally an entity having two or more members that is organized
under the California limited liability company provisions. Two members
required in some jurisdictions - but not in California, where an
LLC may have just one member, unless the member is a trust.
A member of a limited liability company may be
an individual, partnership, limited partnership, trust, estate,
association, corporation, another limited liability company, or
other domestic or foreign entity. For tax purposes, an LLC is a
WHAT ARE SOME OF THE RULES AND BENEFITS
OF A LIMITED LIABILITY COMPANY?
An LLC is not subject to federal taxation
at the entity level. Instead items of income, deduction, loss,
and credit are passed through to the individual member.
A member of an LLC ordinarily is not liable
for the debts and obligations of the LLC solely by virtue of
that membership, however, personal liability may arise only
under the same or similar circumstances, and to the same extent,
as for a shareholder in a corporation. Even then, the failure
to hold meetings of members or to follow formalities with respect
to meetings does not tend to establish personal liability for
members of an LLC, as it does in the corporate context. Members
of LLCs are, however, liable for participation in tortuous or
Unless the articles of organization or operating
agreement provide otherwise, the members of an LLC cannot be
required to make additional contributions to the entity.
Managers and officers of LLCs are not personally
liable for debts and obligations of those entities solely by
virtue of their positions, but they may agree to be personally
Managers do owe the same fiduciary duties to
the LLC as partners owe to a Partnership, and officers owe to
a Corporation and may be held liable for breach of that duty.
An LLC may have unlimited continuity of existence.
Although a specified date of dissolution of an LLC must be stated
in its articles of organization, and an LLC must be dissolved
at that time, an LLC does not lack continuity of existence because
the termination date can always be amended.
An LLC may specify in its articles of organization
or a written operating agreement that any particular event will
cause its dissolution. The vote of a majority in interest of
the members (or a greater percentage voting interests of members
as may be specified in the articles of organization or written
operating agreement) dissolves an LLC, as does an entry of a
decree of judicial dissolution.
Unless otherwise provided in the articles of
organization or written operating agreement, an LLC must dissolve
on the death, bankruptcy, retirement, resignation, expulsion,
or dissolution of any member who is a manager (for LLCs managed
by managers who are members), or any member (for LLCs managed
by their members or by managers who are not members). Even this
requirement does not prevent continuity of existence, however,
because a majority in interest of the remaining members may
vote to continue the business of the LLC within 90 days of the
An economic interest in an LLC (as distinct
from a membership interest) is freely assignable, and an assignment
of an economic interest does not of itself dissolve the LLC.
Unless otherwise provided in the articles of organization or
operating agreement, however, a membership interest in an LLC
may be assigned only with the consent of a majority in interest
of the members not transferring their interests. Without that
approval, the assignment entitles the assignee only to receive
distributions and allocations of income, gains, losses, deductions,
credit or similar items from the LLC to which the assignor was
If an individual member of an LLC dies or is
adjudged incompetent, that member's legal representative may
exercise all of the member's rights for purposes of settling
the member's estate or administering the member's property.
Management and control of an LLC may be vested in a manager
or managers, or may be conducted by the members themselves.
Managers may, but need not be, members of the LLC.
The articles of organization or operating agreement
may also restrict or enlarge the management rights and duties
of any member or class of members.
Any person acting as a manager has the same
fiduciary duties to the LLC and its members as a partner has
to a partnership and other partners of the partnership. An LLC
may also provide for the appointment of various officers, who
may or may not be members or managers of the LLC.
Limited liability companies must comply with
various statutory record keeping and compliance formalities,
but are normally less stringent and less costly than those incurred
Limited liability companies must maintain specified
records of members and managers, and keep books and records
as required by statute. Meetings of members and managers must
be noticed, conducted, and adjourned in a manner prescribed
Advantages of forming an LLC
. . .
- An LLC is a hybrid between a partnership and
a Corporation in that it
combines the "pass-through" treatment of a partnership with the
limited liability accorded to corporate shareholders. The
assistance of a qualified tax professional is recommended, as the
area of taxation is complex and changes often.
- In an LLC, the profits and losses can be
specially allocated in any manner agreeable to the parties.
Another major difference is how appreciated assets are treated in
a liquidation. Partnerships, and consequently LLCs, will almost
always offer the best tax results on the sale of assets or
complete liquidation. For this reason, LLCs are often recommended
for enterprises where assets will be obtained, or created (e.g.
intellectual property) and subsequently sold after they have
- Unlike a corporation which can have as few
as one shareholder, most states require that an LLC consist of
two or more members (owners). Recently, however, more states,
including California, are allowing single-member LLCs.
Please note, however, that the IRS may treat
a single-person LLC differently than an LLC with more than one member.
The assistance of a qualified tax professional is recommended, since
the area of taxation is complex and changes often.
Separate Legal Entity . . .
Like Limited Partnerships
and Corporations, an LLC is recognized
as a separate legal entity from its "members." Limited Liability:
Ordinarily, only the LLC is responsible for the company's debts
thus shielding the members from individual liability. However, there
are some exceptions where individual members may be held liable:
Guarantor Liability . . .
Where an LLC member has personally guaranteed
an obligation of the LLC, just as with corporation, he or she will
be liable on that guaranty. For example, where an LLC is relatively
new and has no credit history, a prospective landlord about to lease
office space to the LLC will most likely require a personal guarantee
from the LLC members before executing such a lease. In fact, in
California, all closely held corporations can expect a landlord
to require the owners to guaranty the rent.
Alter Ego Liability . . .
Very similar to the judicial doctrine applied
to corporations where a court may hold the individual shareholders
liable where the business entity is merely the "alter ego" of its
shareholders, a member of an LLC may also be held liable for the
LLCs debts if the court imposes its "alter ego liability" doctrine.
Please note that although a corporation's failure to hold shareholder
or director meetings may subject the corporation to alter ego liability,
this is not the case for LLCs in California. An LLCs failure to
hold meetings of members or managers is not usually considered grounds
for imposing the alter ego doctrine where the LLCs Articles of Organization
or Operating Agreement do not expressly require such meetings.
Management and control . . .
Management and control of an LLC is vested with
its members unless the articles of organization provide otherwise.
Voting Interest: Ordinarily, voting interest directly corresponds
to interest in profits, unless the articles of organization or operating
agreement provide otherwise.
Transferability . . .
No one can become a member of an LLC (either
by transfer of an existing membership or the issuance of a new one)
without the consent of members having a majority in interest (excluding
the person acquiring the membership interest) unless the articles
of organization provide otherwise.
Duration . . .
Although many states now allow an LLC to have
a perpetual existence, LLCs traditionally were required to specify
the date on which the LLCs existence will terminate. In most cases,
unless otherwise provided in the articles of organization or a written
operating agreement, an LLC is dissolved at the death, withdrawal,
resignation, expulsion, or bankruptcy of a member, unless within
90 days a majority in both the profits and capital interests vote
to continue the LLC.
Formalities . . .
The existence of an LLC begins upon the filing
of the Articles of Organization with the Secretary of State. The
articles must be on the form prescribed by the Secretary of State.
Among the required information on the form is the latest date at
which the LLC is to dissolve and a statement as to whether the LLC
will be managed by one manager, more than one manager, or the members.
To complete the formation of the LLC, members
must enter into an Operating Agreement. This Operating Agreement
may come into existence either before or after the filing of the
Articles of Organization and may be either oral or in writing. A
carefully drafted written Operating Agreement is recommended, since
it will assist in preventing differences of recollection in the
event of later disagreements between the LLCs members.
The Law Offices of David D. Murray can form a
Limited Liability Company or Corporation in any state in the United
States and can can also advise on the formation of Offshore Companies.
FAQ's ABOUT LIMITED LIABILITY
QUESTION: What is a Limited Liability
ANSWER: California adopted a Limited Liability
Company law in late 1994. An LLC is an entity which offers its
owners limited liability, but is taxed more like a partnership.
The liability of the individual members can be protected, except
for personal tort or criminal conduct.
QUESTION: Isn't that what a corporation that
has elected to be treated
for tax purposes under Subchapter "S" of the Internal
Revenue Code is?
ANSWER: Subchapter "S" corporations
are taxed in their own unique way. An LLC, if set up in a certain
way, are taxed on the federal level just like partnerships. Before
we get to the tax implications, there are non-tax differences
between the "Sub-S" corporation and an LLC. "Sub-S"
corporations may have only 75 shareholders, and the holders must
be individuals or certain trusts. Other business entities, like
corporations, and nonresident aliens may not be shareholders of
a "Sub-S" corporation. There are no such limitations
on the owners of a LLC. Sub-S corporations may only have one class
of stock, so all of the owners must have the same rights and privileges.
In an LLC you have flexibility in fashioning the relationship
among the owners.
QUESTION: What are the tax differences between
an LLC and a
Corporation that has elected for tax treatment under IRC Subchapter
ANSWER: First, both entities pass the
business' profits and losses through to the owners, but in the
"Sub-S" tax election, all allocations must be made strictly
according to ownership interests. In an LLC the profits and losses
can be specially allocated in any manner agreeable to the parties.
Another major difference is how appreciated assets are treated
in a liquidation. Partnerships, and consequently LLCs, will almost
always offer the best tax results on the sale of assets or complete
liquidation. For this reason, LLCs are often recommended for enterprises
where assets will be obtained, or created (e.g. intellectual property)
and subsequently sold after they have appreciated. The assistance
of a qualified tax professional is recommended, as the area of
taxation is complex and changes often.
QUESTION: Are LLCs difficult to form?
and no. The filing requirements are not complicated, and are accomplished
using forms from the Secretary of State. However, LLCs do require
an agreement among the members, and those agreements can be very
QUESTION: Is there any easy way to determine
the best entity
for a particular business?
really. Everything depends on the individual situation. First,
think about what your goals are. It is not enough to know what
kind of business you are operating, you also need to think about
whether you are going to use the business to defer income; are
you going to bring in other investors?; are you planning on selling
the business or some or all of its assets? You should meet with
your attorney and your tax accountant to review both the legal
and the tax issues of forming a business entity.
CONCLUSION . . .
Chosing a business entity must be made through
a careful weighing and balancing of all the interrelated tax and
non-tax factors involved in the formation and conduct of a business
venture. It cannot be overemphasized that this choice must be
made on a case-by-case basis and must be tailored to the specific
tax, legal, and financial objectives and expectations of the principals
involved in the venture. Both short-term and long-term objectives
must be determined. The choice of the proper business entity need
not be made at the inception of a venture. It is an ongoing decision
that requires review and reconsideration at least yearly in the
light of changing tax laws and the changing circumstances of the
business and its principals. Changes can always be made when the
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