Limited Liability Company (LLC)
The limited liability company (LLC) is a relatively recent innovation in the law that grew out of the need for an entity that had limited liability like a corporation but shared the tax attributes of a partnership. As a result, LLCs have some characteristics that are similar to those of a partnership, some corporation-like characteristics, and still other characteristics that are unique to the LLC form of business organization.
The limited liability company first appeared in Wyoming in 1977, but because of the uncertain tax status of the new entity, other states were slow to follow Wyoming’s lead until 1988, when the IRS issued a revenue ruling stating that it would treat a Wyoming-style LLC as a partnership for tax purposes. It was not until 1993 that Nebraska first authorized the creation of LLCs.
Like a corporation, a limited liability company is a legal entity that is separate and distinct from its owners, who are called “members.” Operating procedures for the LLC are set forth in its articles of organization and in its operating agreement, which is similar to a partnership agreement. Management of the company may be vested in the member(s) or a manager may be named which may or may not have an ownership interest. With the exception of liabilities for unpaid taxes, members and managers of a LLC are not liable for LLC debt, liabilities, or other obligations.
Like the shareholders in a business corporation, the members of LLCs enjoy the corporate characteristic of limited liability. Simply put, a business owner has “limited liability” if the business entity, and not the owner, is responsible for the debts and obligations of the business. In other words, if the business should get into financial difficulty, only the business assets and not the personal assets of its owners are at risk. As a separate legal entity, the LLC must establish and maintain independent financial records and accounts, and business must be conducted in the name of the company in order for the members to enjoy the protection from personal liability. The limitation of liability can be nullified if members give personal guarantees for the LLC, the same as in the case of a corporation.
Continuity of Life
An LLC also has the corporate characteristic of “continuous life,” because it does not cease when its owners change or die. Unlike partnerships, the LLC business entity goes on until the date specified in the articles of organization or until it is dissolved by some deliberate action of the owners or governmental authorities.
Transferability of Interests
An ownership interest in a LLC is part of a member’s personal estate and can be transferred or assigned according to procedures specified in the articles of organization or in the operating agreement. Under the Nebraska statute, if neither the articles of organization nor the operating agreement specifies a procedure for an ownership interest transfer, the transferee, may not participate in management decisions unless the transfer has been approved in writing by a majority in interest of members other than the transferor. In that event, the transferee has only the right to share in profits or other compensation and in the return of capital, the same as in the case of transfer of a partnership interest.
Ability to Contract
Like a corporation, an LLC is an distinct legal entity that is separate from the people who own and manage it. In sight of the law, the LLC as a legal “person” that can enter contracts, incur debts, sue and be sued, and pay taxes apart from its owners.
The federal income tax filing status of a LLC is determined by an election made when the income tax return is filed. An LLC has the option of being taxed as a corporation. Unless the LLC elects to be taxed as a corporation, a single-member LLC is taxed as a sole proprietorship and a multiple-member LLC is taxed as a partnership. A LLC owned by a corporation will be taxed as a corporate division. State income tax filing status is the same as federal income tax filing status.
Generally, a withdrawal of assets from a corporation will be taxed as a dividend received by the shareholder except upon complete liquidation of that shareholder’s interest in the company. However, when an LLC is taxed as a sole proprietorship or as a partnership and assets are withdrawn from the LLC, the tax consequences are the same as the same transactions by a sole proprietorship or a partnership. This characteristic makes placing land and other appreciating assets in a LLC with sole proprietorship or partnership tax status presently appears to be much more advantageous than placing such assets in a corporation.
When partnership taxation is elected, net operating income or loss and capital gains and losses pass through to members for taxation purposes and are subject to state and federal income tax and, where applicable, to self-employment tax. Another difference from corporate taxation is that distributions of LLC income can either be proportional to ownership interests or in compliance with a pattern established in the articles of organization or operating agreement that may be tailored to the needs and interests of family members, for example.