Terminology Overview:

What are Limited Liability Companies?

The limited liability company (LLC) is a relative newcomer to the business world. A unique alternative to the five traditional forms of doing business, the LLC in essence establishes a business that combines the limited liability of a corporation with the level of tax simplicity associated with a partnership. This form of doing business generally offers greater business, legal and tax advantages than a C corporation, S corporation, general or limited partnerships.

Similar to an S corporation, an LLC offers liability protection for owners. This means that limited liability companies basically let owners off the hook for business debts and other legal liabilities obtained against the business. In addition, LLCs are allowed by the IRS to use the "passthrough" method of reporting taxes. This means that owners of LLCs can pass business profits and losses through to the owner's personal income tax returns rather than be taxed at a separate business level.

Each LLC ownership interest may consist of various management, voting, and distribution characteristics similar to different classes of stock. Members who invest in a LLC receive a percentage ownership interest in return. The ownership percentage may be used to divide assets when a company is sold or liquidated, to divide up its voting rights and to divide up profits and losses. This percentage does not need to be the deciding factor in assigning owners profits and losses however. LLC business owners have the right to divide profits and losses amongst themselves in any way they wish.

In regards to shareholders, limited liability companies have fewer restrictions. LLCs have no limit on the number of shareholders that are allowed within the company. Shareholders can be foreign, and corporations and partnerships can also be shareholders. The only additional restriction LLCs have compared to S corporations is that sole-proprietors and professionals cannot always form LLCs. As of January 2000, the District of Columbia and Massachusetts are the only two states that do not allow single-member LLCs.

If you use an LLC form, you may be able to shift income to a child or family member while still retaining control and voting rights of the company. Existing partnerships may convert to the LLC form with no tax consequences. However, existing C or S corporations must first go through an actual or deemed taxable liquidation.

Following are some more factors that relate to limited liability companies:

  • There may be some severe restrictions in some states regarding the transfer of ownership. Some require the unanimous consent of all members while others require majority consent before ownership can be transferred.
  • Restrictions regarding the resignation of members differ from state to state. In some instances, a member is required to give as much as six months notice before resigning.
  • Many laws pertaining to LLCs are still evolving and can put members at a legal disadvantage when trying to interpret the laws pertaining to their company.