Understanding LLC is as simple as weighing the advantages and disadvantages of this business structure for your company. You might be starting a new business or have a partnership or sole proprietorship that could benefit from being registered as a limited liability company (LLC). An LLC is a relatively new form of business entity that was established in the 1970s. LLC formation initially had slow growth due to its uncertain tax treatment with the IRS.

To be able to enjoy the benefits of pass-through taxation that this business structure can provide, your LLC must have at least two members. Because of its tax benefits, electing for LLC designation is popular among real estate holdings as well as small businesses.

Why LLCs Are Popular

There are many reasons business owners might elect to form their businesses as LLCs. Some of the most popular reasons for choosing an LLC include:

  • They can be formed with a single member.
  • They are easy to form.
  • They offer pass-through taxation for multiple-member LLCs.
  • Members can enjoy the protection of their personal assets from business debts and suits or legal claims against the business.
  • There are fewer filing and meeting requirements when compared to corporations.
  • They have more flexibility when structuring management.
  • They are simple to maintain.

If forming an LLC with your spouse as the additional member, you will be classified as a "disregarded tax entity" and have taxes pass through the company to your personal tax returns.

Personal Liability Protection of an LLC

Limited liability company (LLC) owners have the same limited liability protection as if they were corporation shareholders. This means that, except under rare occurrences, an owner can protect his or her personal assets from being used to satisfy business debts.

There is one way in which LLC liability does differ from that of a corporation. A creditor can seek a personal judgment against an LLC member by requesting a charging order. This could result in a claim against the member's economic interest in the business, but that individual's personal assets (house, savings, etc.) remain protected. In a general partnership or sole proprietorship, there is no separation between business and personal assets. Under these structures, a creditor could pursue personal assets to settle a debt.

In the event of a charging order, cash distributions that would normally be paid to the member will be made as payment to the creditor until the debt is satisfied. Even though the creditor is getting the distributions, they will not be entitled to the voting rights or management participation that the member would normally enjoy.

If the LLC has drafted a proper operating agreement, any majority voting issues could have a contingency plan in the event of this occurrence.

The Management Structure of LLCs and Operating Agreements

An LLC allows for greater flexibility and more options when creating a management structure. This is particularly advantageous for LLC with multiple members and/or managers. An LLC can be:

  • Member-managed, in which the company is run solely by its members.
  • Managed by member-appointed officers.
  • Manager-managed, in which the members designate managers to run the company's day-to-day operations. This type of structure is most similar to that of a corporation.

An LLC also offers its members the option to draft a customized operating agreement that provides the members with the ability to structure their company how they choose. An operating agreement is similar to a partnership agreement between the managers and members of an LLC. It lays out the rights and responsibilities of all parties. An operating agreement typically includes:

  • The duties and responsibilities of members and management.
  • Each manager and member's rights, powers, permission, and restrictions.
  • How transferring membership interest will occur.
  • How membership interest will be valued.

Along with the above inclusions, a well-drafted operating agreement will also include such member-related issues as:

  • Compensation for management.
  • Expected time commitment from members.
  • The procedures for member removal.
  • The types of issues that require member approval.
  • Voting rights and decisions that require unanimous voting.

If you do choose to create an operating agreement for your LLC, you might want to hire an experienced attorney to make sure it's done properly.

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