If you're wondering "when did the LLC start," LLCs are a still relatively new business structure type that began in the 1970s. It is important to know that the LLC business structure is still evolving. The IRS is looking to fill perceived gaps while the LLC structures continue to grow in popularity.

What Is an LLC?

A limited liability company (LLC) is a crossbreed of the corporate, partnership, and sole proprietorship structures. It inherits liability protection from the corporation and the pass-through taxation from the partnership and sole proprietorship entities. Key features of an LLC include the following:

  • Liability protection to their owners. This means the LLC owners (called members), in most cases, are not liable for business debt.
  • No double taxation. Like sole proprietorships and partnerships, LLCs enjoy pass-through taxation benefits. They are not subject to double taxation like corporations. Instead, LLC owners (called members) report profits and losses on their personal taxes.
  • Flexibility in profit distribution. Members do not have to distribute profits to match member-interest percentage.
  • Informal business operations. LLC members can choose whether they are member-managed or manager-managed. They do not have a formal board or record meeting minutes.

History of the Limited Liability Company

In 1977, Wyoming established the first limited liability company. It took the IRS 11 years to recognize this entity with the Delaware LLC Act. This act set a precedent with asset protection and IRS-approved pass-through taxation. Because owners were able to establish how their organization will run and because of the lack of rigid guidelines, the Delaware LLC Act became the blueprint for LLC formation in other states.

The LLC structure is not without controversy. The IRS wants to make sure they are collecting enough taxes while state laws continue to adjust to meet the business needs. LLC laws are not consistent across states, though there are some accepted standards. With that said, LLC laws will continue to evolve.

Advantages of an LLC

  • LLCs protect their owners (called members) from personal liability for business debt. They can only lose the money they invested in the company.
  • LLCs are not subject to double taxation. The LLC is a pass-through entity. The business entity itself does not pay federal taxes. Instead, the members claim their profits and losses on their tax return.
  • LLCs are easier to set up than corporations. Though you must register an LLC with the state, the statutes are more relaxed compared to a corporation.
  • Profit distribution among the members does not have to align with member interest in the company. A member can own 20 percent of the company and get 50 percent of the profits.
  • Another entity, such as a corporation or another LLC, can be an LLC member.
  • An LLC can exist even after one of its members dies. The operating agreement needs to outline what happens if a member dies.

Drawbacks of Forming an LLC

  • Since LLCs are relatively new, the laws are still evolving.
  • Each state has their own statutes for LLCs, so it makes doing business across state lines complicated.
  • If you do not state guidelines for what happens to an LLC if a member dies or wants to withdraw membership, it is at risk of closing.
  • Not all businesses qualify for the limited liability protection, such as non-profit organizations, insurance companies, banks, and professional services companies, like doctors.
  • If you are a managing member of the company, your profit share is subject to self-employment taxes.

How Will My LLC Be Taxed?

The IRS does not recognize an LLC as a legal entity; therefore, it is not subject to taxes. Instead, those taxes are passed on to the members. Each member is responsible for paying taxes on their profit share.

What Security Laws Impact LLCs

You only have to worry about security laws if you have a multi-member LLC. If the Securities and Exchange Commission (SEC) considers member-interest securities, make sure you qualify for exemption before accepting investor money or registering the interest sale with your state and the federal SEC.

LLCs are still in their infancy. While there is flexibility in starting one, you still must understand the LLC statutes in your state. There are circumstances where you can lose your LLC status with a misstep. Contact your state office to make sure you understand the LLC laws.

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