Limited Liability Company

Limited liability companies, or LLCs, are becoming more and more popular, and it's easy to see why. They combine the personal liability protection of a corporation with the tax benefits and simplicity of a partnership. In other words, the owners (or "members") of an LLC are not personally liable for its debts and liabilities, but also have the benefit of being taxed only once on their profits. Moreover, LLCs are more flexible and require less ongoing paperwork than an S-Corporation.

To avoid double taxation, corporations can make a special tax election, known as a "subchapter S election", to be taxed as a flow-through entity like a partnership and LLC. Corporations which make the subchapter S election are known as "S-corporations", and corporations which do not are known as "C-corporations." However, there are still important differences between S-corporations and LLCs.

LLC - Advantages and Disadvantages

Advantages:

There are fewer corporate formalities for LLC's:
Corporations must hold regular meetings of the board of directors and shareholders, keep written corporate minutes and file annual reports with the state. Members and managers of an LLC need not hold regular meetings, which reduces complications and paperwork.

No ownership restrictions:
S-corporations cannot have more than 75 stockholders, and each stockholder must be a natural person who is a resident or citizen of the United States. There are no such restrictions placed on an LLC.

Ability to use the cash method of accounting:
Unlike a C-corporation, which often must use the accrual method of accounting, most limited liability companies can use the cash method of accounting. This means that income is not earned until it is received.

Ability to place membership interests in a living trust:
Members of an LLC are free to place their membership interests in a living trust. It is difficult to place shares of an S-corporation into a living trust.

Ability to deduct losses:
Members who are active participants in the business of an LLC are able to deduct its operating losses against the member's regular income to the extent permitted by law. Shareholders of an S-corporation are also able to deduct operating losses, but shareholders of a C-corporation are not.

Unemployment tax:
A member-employee of an LLC is not required to pay unemployment insurance taxes on his or her salary. Shareholder-employees of corporations must pay this tax. Currently, the federal unemployment tax is 6.2% of the first $7,000 of wages paid, to a maximum of $434 per employee.

Disadvantages:

Profits are subject to social security and medicare taxes:
In some circumstances, owner-employees of an LLC may end up paying more taxes than owner-employees of a corporation. Salaries and profits of an LLC are subject to self-employment taxes, currently equal to a combined 15.3%. With a corporation, only salaries (and not profits) are subject to such taxes. This disadvantage is most significant for member-employees who take a salary of less than $72,600.
Example:
Assume a member earns $30,000 in salary and is distributed $20,000 of the LLC's profits, a 15.3% tax would have to be paid on $50,000. For an S-corporation, social security and medicare taxes would only have to be paid on the $30,000 salary.

Owners must immediately recognize profits:
A C-corporation does not have to immediately distribute its profits to its shareholders as a dividend. This means that shareholders in a C-corporation are not always taxed on the corporation's profits. Because an LLC is not subject to double-taxation, the profits of the LLC are automatically included in a member's income.

Fewer tax exempt fringe benefits:
Member-employees of an LLC who receive fringe benefits, such as group insurance, medical reimbursement plans, medical insurance and parking, must treat these benefits as taxable income. The same is true for stockholder-employees who own more than 2% of an S-corporation. However, stockholder-employees of a C-corporation who receive fringe benefits do not have to report these benefits as taxable income.

LLC vs. Proprietorships & Partnerships

How does an LLC compare to a sole proprietorship and partnership?

Advantages:

Owners are not personally responsible for company debts. This is the most important aspect of an LLC. In a sole proprietorship and partnership, the owners are personally responsible for the debts of the business. If the assets of the sole proprietorship or partnership cannot satisfy the debt, creditors can go after each owner's personal bank account, house, etc. to make up the difference. By contrast, if an LLC runs out of funds, the owners are usually off the hook.

Please note that under certain circumstances, an individual member may be liable for the debts of an LLC. These circumstances include:

If a member personally guarantees a debt.
If the LLC fails to have a separate bank account and personal funds are intermingled with LLC funds.
If the LLC has minimal capitalization or minimal insurance.
If the LLC fails to pay state taxes or otherwise violates state law.

Easier to raise money:
An LLC has many avenues to raise capital. It can admit new members by selling membership interests, and it can create new classes of membership interests with different voting or profit characteristics. Plus, investors will rest assured that they will not be personally liable for company debts.

Ease of transfer:
Ownership interests in a limited liability company may be sold to third parties without disturbing the continued operation of the business. The business of a sole proprietorship or partnership, on the other hand, cannot be sold whole; instead, each of its assets, licenses and permits must be individually transferred. New bank accounts and tax identification numbers are also required.

Disadvantages

Cost:
LLCs cost more to set up and run than a sole proprietorship or partnership. For example, there are the initial formation fees, filing fees and annual state fees. These costs are partially offset by lower insurance costs.

Formal organization:
Although an LLC requires less formalities than a corporation, there is still more paperwork involved than a sole proprietorship or partnership. A sole proprietorship or partnership can commence and operate without any formal organizing procedures; not even a hand written agreement is required.

Separate records:
In order to maintain the separate form of the LLC and maintain the liability protection of its members, the owners of the LLC must carefully maintain separate records and keep their personal business separate from the LLC's business. Even more importantly, the LLC's money should never be intermingled with personal money.

How to form an LLC

The life of an LLC begins upon the filing of the articles of organization with the secretary of state's office. Prior to filing the articles, the following issues should be considered. Get Maryland LLC articles of organization

Where should I form the LLC?

An LLC can be formed in all states. Many people choose to form an LLC in Delaware based on its pro-business climate. Nevada has also gained popularity also due to its pro-business environment and lack of a formal information-sharing agreement with the IRS. Neither Delaware nor Nevada have corporate income taxes, and business filings in these states can usually be performed more quickly than in other states.
Many people also choose to form LLCs in their home state. This may save you money because the LLC will not need to register as a "foreign LLC" if it does business in its home state, and there is no need to pay another person to serve as the registered agent.
If your home state has high annual LLC fees or income taxes, and your LLC does not "do business" in that state, it may be wise to form the LLC elsewhere. "Doing business" means more than just selling products or making passive investments in that state - it usually requires having an office or otherwise having an active business presence.

Choosing a name:

Generally, the name of a limited liability company must end with the words "LLC", "L.L.C.", "Limited Liability Company" or "Ltd. Liability Co." The name of a person may be used as part of the name of the limited liability company. However, a name will not be accepted if it is likely to mislead the public or if it too closely resembles the name of another LLC formed in that state.

Before you choose the name, you should do a little research to see if the name is taken. You can search yourself at Yellowpages.com, Switchboard.com or the Secretary of State of the state in which you wish to form your LLC.
If the name of the LLC is used in connection with goods or services, you may wish to consider obtaining federal trademark protection for the name. This ensures that no one else in the U.S. may use that name in connection with the same general type of goods or services (except in areas where someone else is already using that name).

How to Manage an LLC

A limited liability company may be managed either by (a) the members or (b) one or more managers. A "member" is an owner of the limited liability company. If a limited liability company is managed by the members, then the owners are directly responsible for running the company.
A "manager" is a person elected by the members to manage the limited liability company. In this context, a manager is similar to a director of a corporation, or a member of Congress. A manager can be, but is not required to be, a member. If a limited liability company is managed by managers, then its members are not be directly responsible for running the company.

Whether an LLC should be managed by members or managers depends on several factors, including:

The number of owners
The type of business
Where the owners are located
How involved the members will be in the operations of the LLC.
Management by members is usually the best option for LLCs that have only one member or just a few members, all actively participating in the affairs of the LLC. If there are many members, on the other hand, including some that do not actively participate in the operations of the LLC (such as silent partners), then management by managers may be the best option.

Officers

Regardless of how a limited liability company is managed, it can still appoint officers to run the day-to-day operations of the company. An LLC is not, however, required to have officers. Officers serve at the pleasure of either (a) the managers, if the limited liability company is managed by managers, or (b) the members, if the limited liability company is member-managed. Members or managers may both be officers. There is no limit on the maximum number of officers, nor is there a limit on the number of offices that a person may hold. In fact, the same person may hold all offices.

Meetings

Regular or annual meetings of the members or managers are not required. The operating agreement included with the Legal Zoom LLC formation package does not require regular meetings, but states that meetings may be held as the members or managers deem them necessary to run the company. Even though it's not required by law, it may be a good idea to keep records of the actions taken or approved at the meetings.

Registered Agent

Each LLC must have a registered agent, the person designated to accept official notice if the LLC is "served" with a lawsuit. A registered agent must be either (1) an adult living in the state of formation with a street address (P.O. boxes are not acceptable) or (2) a company registered with the Secretary of State in the state of formation.

Captial Contributions and Ownership of an LLC

Ownership in an LLC can be expressed in two ways: (1) by percentage; and (2) by membership units, which are similar to shares of stock in a corporation. In either case, ownership confers the right to vote and the right to share in the profits of the LLC.

An LLC can distribute its ownership interests as it pleases, without regard to how much money or property a member contributes to the company. For example, if one member contributes $10,000 to the company and is a silent partner, and another contributes no money but runs the company on a daily basis, they could still decide to split the membership interests 50%-50%.

A limited liability company can also be organized with different classes of ownership interests, which provides flexibility for special allocations of profits and voting power. You are permitted to create a special class of "super-voting" units that provide 5 votes per unit or pay a certain level of profit before the "regular" units.

Like sale of corporate securities (stock), the sale of membership interests is also subject to securities laws. Generally though, if you are not advertising the sale and are dealing only with a small number (less than 35) of knowledgeable and sophisticated investors, then you will be exempt from the regulations. If, however, you are seeking to raise a significant amount of money from a large number of investors, it will be necessary to consult an attorney.

Assignment and transfer of ownership interests:

Transfer of membership interests generally requires the consent of other members. It is possible to create articles of organization that does not require consent of other members. This is an important issue to consider for any LLC with more than one member. On one hand, you may wish to sell or transfer your membership units to anyone you wish. On the other, if you consider the other members of the LLC your business partners, you may want approval over whether they can transfer their interest and who they can transfer it to. If your plans may at any time include raising funds publicly, you are advised that venture capitalists sometimes shun LLC's because it may require changing the LLC to a C-corporation at considerable expense.

Tax forms and licenses:

LLCs may be required to obtain a federal tax identification number. However, there are some situations where an LLC can simply use the social security number of the owner. City and county business licenses may also be required. Please check with an accountant about the need for a tax ID number and your city and county to see which types of licenses are needed.