Forming a corporation limits personal liability for business debts and losses, while using a partnership form provides substantial tax advantages. Limited liability company laws combine these two advantages into one business form, simplifying the choice of business entity for many businesses.
Limited liability companies receive the same tax treatment as partnerships. Unlike corporations, partnership and limited liability company profits and losses are not taxed at the corporate level; they pass through to the individual owners. Instead of being taxed at a higher corporate rate, the business income is imputed directly to the owners and is taxed at their individual income tax rates. Therefore, gains are taxed only once, instead of the double taxation imposed on some corporate earnings.
Example: Gene and Bill open a limited liability company, G&B Industries, LLC. In the first year, the company's profits are $20,000. Gene and Bill each take $10,000 out of the business, which is taxed as part of their individual incomes rather than being taxed once as part of G&B's profits and again when Gene and Bill receive income as the shareholders.
While limited liability companies allow their owners to benefit from lower tax rates, they also insulate owners from many legal risks. As with corporations, the limited liability company retains liability for business debts and obligations. Unless the owners assume certain roles or behave contrary to shareholder and public interests, the business owners do not take on personal liability for organizational debts.
Example: G&B Industries breaches a contract with a supplier, who files a lawsuit. G&B loses the lawsuit and the court orders the company to pay $100,000 in damages. G&B's assets are inadequate to satisfy the verdict, but the supplier cannot look to Gene and Bill's personal assets to make up the deficiency. The supplier receives only the amount that the limited liability company is able to pay.
Because limited liability companies exist by virtue of state statutes, business owners must comply with all legal requirements in order to retain their LLC status. Limited liability companies generally must have two or more shareholders at all times; corporations need no more than one shareholder. Limited liability companies must observe corporate formalities. They must maintain their corporate registration and file any documents or reports required by the state. Limited liability companies must hold shareholder and board meetings, keep corporate records, issue shares and comply with by-laws and articles of incorporation. If owners ignore corporate formalities, they could open themselves to personal liability or other negative legal consequences.
The tax and liability implications of limited liability companies are attractive, but business owners would benefit from legal advice to take full advantage of this business form. Other reasons may exist for choosing business entities like partnerships or corporations. If you have questions about tax or liability for your business, contact an experienced business law attorney.
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