Limited Liability Company (LLC)

Any person carrying out business in his personal capacity is entitled for its gains and liable for its losses incurred. After all no one wishes to make loses in business. It's the inherent nature of some transactions or unforeseen events which leads to losses in business. This very nature of personal liability of person carrying out the business gave birth to need for limited liability of a business. This was not possible unless the business and person is treated as two different legal entities. With this aim to limit liability the concept of corporations came in to existence.

The similar nature of corporate structure having the benefits of limited liability gave birth to Limited Liability Companies with lesser complexity, compliance and fewer record maintenance requirements.

An Limited Liability Companies provides a limited liability to its owners (typically known as members). An Limited Liability Companies is not a corporation technically; it is in the nature of a company legally. It is not mandatory to form an Limited Liability Companies with a motive to make profits. An Limited Liability Companies may be formed for a not for profit activities. In some parts of United States, any business engaging in the activity of profession involving medicine, law or accounting requires special licensing from state. Such entities are not registered as LLPs but a professional limited liability company (PLLC).

A Limited Liability Company (LLC) has characteristics of a corporation and a partnership/ sole proprietorship. Technically an LLC is not a corporate entity. The main feature of a LLC which resembles with a corporation is limited liability of its members. However, it is much more flexible than a corporation and is best suited for smaller organizations where the control is concentrated in very few hands.

In the absence of implied statutory guidance and laws pertaining to LLC, it is help by most of the courts that common laws applicable to corporate laws are also applicable to LLCs. As LLPs are subject to lesser stringent compliances, it is difficult to associate the action of LLCs to its members. As long as there is clear indication of fraud, it is difficult to lift the veil.

Just like a corporate has share-holders, an LLC has members. An LLC can have one or more than one members. The number of members required to form an LLC varies from state to state.  Tax on the income of LLC is not assessed for LLCs and members need to add the share of income from LLC in their individual incomes and pay taxes on it accordingly.

Procedure for forming an LLC

Procedure for forming an LLC varies slightly from state to state but overall steps involved in formation of LLC remains more or less the same which can be encapsulated below:

Selecting name for  Business- We must keep the following in mind while choosing name for your business: (1) The name must be different from the existing name acquired by any other business (2) it must indicate that it's an LLC and (3) it must not include restricted words by state

Filing the Articles of Organization-The "articles of organization" is a document that contains information about name of the business, its address, details of its owners etc. The articles include the broad goals of the business entity it wishes to pursue in its general course. The article of organization is required to be filed along with prescribed fee.

Operating Agreement- Operating agreement is not a mandatory thing but it is highly desirable. In a multi-member LLCs, it becomes imperative to have operating agreement in place to have a robust financial and entity structure. It also serves as a guideline for flawless day to day operation. The agreement generally contains guidelines relating to proportion of stake, distribution of profits and losses, rights and obligations of its owners etc.

Getting necessary permissions- It is imperative that once the business is registered, all the necessary permissions to carry out the business are taken from the local authorities. We need to approach the relevant departments and obtain the required licenses and permits to operate the business. Procedures for obtaining licenses vary from state to state and area to area. We need to find out the required licensing requirements as per local laws of the land and obtain the permits to carry out the business before we kick start business operations.

Hiring Employees- Next logical step is to have human capital in place. All human resources need to be in place for running the business. The employee strength and talent pool will vary depending upon the industry we are venturing in to. One more important aspect to remember here is that the employee hiring has to be consonance with the laws of the respective state we are going to set up the business.

Declaring start of business operations- In some states of United States, it is a legal requirement to announce and declare the start of the business operations through a newspaper in circulation in local area. It is worthwhile not to miss on this aspect to avoid complexities later on.

LLC Taxes

Limited Liability Company is not a separate entity for tax purposes. Hence, all the income taxes are passed on to its members and are taxed in their hands as individual tax liabilities. Most of the states do not tax incomes of LLC’s but some states do, it is a better idea to check for the status with respective local state tax authorities/ agencies.

LLC’s need to choose their tax classification as it is not decided by default. They need to fill a prescribed form to get assessed under corporate category. It is imperative to take this step if an LLC wishes to be taxed under different tax status.

Advantages of an LLC

• Limited Liability- The main feature of LLC is the limited liability protection for its members. The liability of its members is limited to the extent of share in the LLC. The debt and obligations of the business cannot be recovered from its members in event of its going defunct. However, it is to be noted that this immunity is not available in case of wrong doings or fraud perpetrated by its members.
• No tax returns- Income of the LLC is assessed in the hands of its members, hence no need for LLC to file separate tax returns.
• No requirement for residency- There is absolutely no need for members of LLC’s to be a permanent citizen or residents of US. Even non-residents or non-citizens can become members of LLC’s.
• Less Recordkeeping- An LLC is required to maintain fewer records as compared to a corporate. This is perceived to be a major advantage most of the times as maintaining records and compliances for a smaller organization is a costly affair and burdensome.
• Sharing of Profits- Distribution of profit is an internal matter for an LLC. The members may distribute the profits as they deem fit amongst themselves. There is no restriction on distribution of profits among its members by LLC.
• Higher reputation and trust- Stakeholders may find it more trustworthy to deal with LLC’s as compared to an individual due to its size, diversity of management team etc.. This can be an additional business pull.

Drawbacks of an LLC

• Short Life Span- In many a cases LLC come to an end with one member of the LLC leaving the LLC. The LLC is dissolved and profit or losses are distributed amongst the members. It poses a biggest threat for existence of the LLC. However, this shortcoming can be taken care of by including a provision in the agreements while forming the LLC for its continuity in case of one or more members leaving the LLC.
• Taxed as Self-Employment- Income of LLC is taxed in the hands of its members. Income is distributed to its members and its members are required to club this income in their returns and pay taxes accordingly. LLC’s are treated as self-employment and are subject to employment tax. In a way, whole income of LLC is subject to employment taxation.
• Limited Growth Potential- LLC cannot issue share capital to public or potential investors limiting it to explore greater growth potential.
• Lack of uniformity- There is no uniformity in status of LLCs in all the states. LLCs are being treated differently in different states. This may pose as serious challenge in terms of comparability of financial statements and ignore strength areas and challenges of LLC’s at individual level.
• Tax implication on conversion- There may be an instance of taxes on conversion of existing business to LLC due to upward valuation of assets.

As of now we have seen various advantages and disadvantages of having an LLC structure of business. Except for New York, the trend is, there are two new LLCs formed for every new corporation coming in to existence. After all what is causing such a growth for LLCs and what is making LLCs so popular? Let’s have a look.

There are two primary reasons contributing to such a phenomenal growth in the number of LLCs:

1. An LLC can have as simple or complicated way of working as its owners wish. If you don’t want to conduct annual meetings, it’s perfectly fine. There is no legal obligation on LLC to conduct an annual meeting!! Don’t want long complicated agreements? Well, simple operating agreements will do most of the stuff. In most states, there are few mandatory requirements for LLCs.
2. An LLC with one member is considered to be a sole proprietorship for tax purposes and an LLC with more than one member is automatically considered to be a partnership. For a single-member LLC, it implies that the LLC is not required to file its own tax return: the profits and losses are included in the income of owner and reported after clubbing. If being a partnership or sole proprietorship is not suitable, we can choose to file a one-page form with the IRS and this will enable converting the LLC into a C or S corporation. The effect, LLC would exactly be treated as a corporation. Flexible operating structure has brought the popularity to LLCs and preference over any other form of entities.

Types of LLC’s

• A Professional Limited Liability Company- A Professional Limited Liability Company (PLLC) is generally formed to provide professional services like doctors, lawyers, interior designers etc. Exact requirements for forming a PLCC differ from state to state. Generally members of PLCC are from the same profession. For example a PLCC engaged in medical line generally have all the doctors as its members. It is to be noted that the immunity of limited liability is not available to its members in case of fraud or misrepresentation.
• A Series LLC- A Series LLC is the one which categorizes its assets or liabilities in a separate series. It is beneficial to have this kind of setup in place to assign specific asset series to a specific liability. The major benefit is that the lender will have access only to the assigned series of assets in case of series LLC.
• L3C-An L3C is a form of for-profit organization in the nature of social venture. It is generally formed to have a social economic goal and not maximizing its income. It combines the benefits of an LLC and a social organization as its face for the purpose of branding.
• Anonymous-An Anonymous LLC is where ownership of the LLC is kept confidential and not disclosed to the public. This arrangement is generally carried out using a third party acting as an intermediary. The degree of disclosure about ownership varies from one state to another state.

Scenario in United Kingdom

Limited liability partnership (LLP) came in existence in the year 2000 in United Kingdom. It is more or less similar to an LLC structure found in United States. Members of LLP are taxed at the partner level and LLP is not subject to taxation. It is treated as a full-fledged body corporate for all other purposes including Value Added Taxes. All other legal entities are subject to corporate taxation. It is an underlying assumption that income belong to the corporate in case of corporation and not its members.