A limited liability company (LLC) is a business partnership formed by two or more parties that provides members with the tax advantages of a partnership, while giving them limited liability. Oftentimes members is the term used to refer to the owners of an LLC. Unlike LLPs, these members can be individuals or corporations. An LLC does not require there to be a general partner who is liable for the partnership’s obligations.
One of the main reasons an individual or partners would choose an LLC over a corporation or other type of business entity because it gives partners the reduced liability of a corporation with the ease of functioning as a sole proprietorship.
Disadvantages of a Limited Liability Company (LLC)
Unlike other types of business entities, a limited liability company (LLC) automatically terminates after the death or bankruptcy of one of the partners. Corporations on the hand have their own lifetime and never expire unless the owner of members of the corporation terminate it. A company that intends on becoming a publicly traded company where stock is sold should not use a limited liability company because this type of business structure makes it difficult to spread shares and liability to members.
LLC’s have a few distinct advantages over other forms of business entities. The main reason businessmen would opt for an LLC is because it limits the partners personal liability in the business. Much like a corporation that is afforded certain protections, a LLC protects individuals person assets, particularly those that have no relation to the business, unlike a partnership which for example intertwines a partner’s personal and business assets. This clearly can be a huge disadvantage because it can make the partner susceptible to greater financial losses in the event a business loses money, has extremely high liabilities, or goes through bankruptcy.
The advantages of an LLC include:
“Pass through” taxes
Legal protection: an LLC’s business assets are legally separated from members’ personal assets, which protects members’ real and personal property, and business income. LLCs have limited business debt liability.
No residency requirement: Unlike LLPs, LLCs do not need to be created by permanent residents of a state or county.
In order to form an LLC, members must do the following:
Choose a business name that is currently not in existence
File Articles of Incorporation. It will include the business name, address, and member names.
Formulate an Agreement. This lays out the roles and responsibilities of each member, the division of profits, and the specifics of the partnership’s business operations.
File the paperwork with the Secretary of State’s Office
Benefit of Limited Liability Company
Limited liability companies are one of the most commonly used business entities to possess real estate holdings. Unlike other forms of ownership that are subject to more stringent requirements, LLCs provide owners more flexibility. In California, LLCs are allowed to structure the LLC according to the needs of the investors and the specifics of the property, whereas corporations must operate according to the standards set in the corporation’s code. The corporation’s code may be stricter and thus more difficult to understand and implement.
One of the main reasons individuals choose to form LLCs rather than other ownership forms is to limit personal liability. In the case of corporations or individual holdings, owners of the business are personally at risk for potential lawsuits. For example, imagine an individual owns a property and a guest of one of the tenants injures him or herself on the property. The injured guest will likely bring a lawsuit against the owner. In this situation, the personal assets of the owner must be defended, whereas if the ownership of the property was held in an LLC, the LLC would incur liability rather than the individual. It is then easier to understand why many real estate investors own properties in LLCs.
The second main reason individuals utilize LLCs is to avoid double taxation that is incurred on other forms of real property ownership. Capital gains from property income will go directly to the owner(s) as individuals, thereby mandated only to pay the individual tax rate, rather than the entity tax and individual tax. Under this form of ownership, owners get the protection of the LLC, while paying the tax rate of individuals, an additional invaluable component that serves to maximize the bottom line of businesses.
The third and oftentimes most important advantage of LLCs over other ownership forms is the flexibility provided by holding property in an LLC. Corporations are required by law to have officers and directors, whereas in a LLC, owners are free to adjust management positions at will. Because the structure of a business changes, LLCs help individuals adjust the LLC structure dependent on the conditions of the market and preferences of owners of the LLC.
An example of how LLCs offer flexibility is the fact that ownership percentages and holdings can easily be transferred and/or willed to an heir. Additionally, there is no restriction on the structure of the LLC, including the minimum or maximum number of shareholders in an entity.
Repurcussions of a Limited Liability Company
If a member of a corporation defaults on obligations, the creditor may be able to foreclose on a shareholder’s ownership right, thereby making the creditor a partner in the business. LLCs, on the other hand, prevent creditors from assuming ownership of the entity. Any member of the LLC can perform any task unless otherwise indicated in the operating agreement. The benefits of an LLC, however, are not without cost. That is LLCs are required to pay higher taxes. Even still, most of the benefits outweigh the increased costs.
Filing an entity as a LLC involves submitting the one page LLC form to the secretary of state’s office.