Legal Forum: The Advantages And Disadvantages Of Setting Up An LLC
I am a sole proprietor of a small HVAC contracting company. A friend told me that I should set my business up as an LLC. What is it, and what are the advantages and disadvantages of setting it up?
LLC is an acronym that stands for “Limited Liability Company.” An LLC is a relatively new form of business organization that combines many of the advantages of corporations and partnerships.
The LLC form was introduced in the United States in 1977 and has been widely adopted by the states only since the early 1990s. Every state now has some form of legislation authorizing the formation of LLCs.
Although state statutes concerning LLCs vary in some key respects, the LLC as a form of business organization shares certain fundamental characteristics in virtually all states. The hallmark of the LLC is that it offers business owners essentially the same protections from liability as forming a corporation; i.e., the owners of the business (referred to as “members” of the LLC) are in general not personally liable for the debts of the LLC. Thus, unlike a partner in a partnership, the liability of a member of an LLC will normally be limited to the value of his or her investment in the LLC.
One of the principal advantages of the LLC form is that this protection from liability can be achieved without many of the formalities usually associated with a corporation. For example, under state law, corporations are generally required to hold annual meetings, maintain appropriate meeting minutes, and take certain actions through resolutions.
In contrast, the members of an LLC generally are not required to engage in any of these activities and may specify the type of management they desire in the operating agreement that is typically used to establish the LLC. Thus, the LLC offers the limited liability advantages of a corporation, but does so in a way that allows business owners greater flexibility in how they manage their business affairs than would be the case if the business was set up as a corporation.
A related advantage is that there are generally no restrictions on how many members an LLC can have (in most states a single member is sufficient), or on who can be a member.
Another notable advantage of the LLC for many business owners is the manner in which LLCs are treated for tax purposes. Pursuant to Internal Revenue Service regulations and revenue rulings, LLCs are treated as partnerships for federal tax purposes and therefore are “pass through” entities, although members can also elect for the LLC to be taxed as a corporation. In other words, LLCs generally do not pay federal income tax. Rather, the income and losses of the LLC are passed through to the members, thereby avoiding the type of double taxation that exists with corporations. Most states treat LLCs in a similar manner for state tax purposes.
Finally, LLCs have the advantage of being relatively easy to establish. Most states require only the filing of articles of formation and the payment of a fee. Most states do not require the filing of an operating agreement, but it is generally a good idea to prepare one, particularly where the LLC has more than one member.
A WORD TO THE WISEWith all of the advantages of the LLC form of business organization, it is important to remember that the LLC is not a panacea. For example, the LLC will not always shield a business owner from personal liability. While case law on LLCs is still evolving, most courts have held that the LLC can be “pierced” and personal liability imposed on a member in the same way that the corporate “veil” can be pierced in some circumstances to impose liability on shareholders.
In addition, many states do have some record keeping requirements for LLCs and may require annual filing fees, making the LLC form potentially more cumbersome and expensive to maintain than a partnership.
Nevertheless, the LLC is an increasingly popular form of business organization, and your friend’s advice deserves serious consideration.
Jackson is an attorney with the Washington, DC, law firm of Kelley, Drye & Warren, LLP.
Note: This feature is intended only as a forum for information and general discussion. Any information provided is not in the nature of legal representation and is not intended to establish any attorney-client relationship. Any information provided should not be relied on without consulting an attorney to discuss the specific facts relevant to your situation.
Publication date: 08/05/2002