LIMITED LIABILITY COMPANIES (LLC)
Congratulations on making the decision to start your own business! As you already know, one critical aspects of business formation is deciding which legal structure your entity will assume, i.e., a limited liability company or corporate entity. The legal structure you select significantly impacts aspects of the company’s legal and financial rights, responsibilities, and limitations throughout the duration of the entity’s existence. For instance, the legal structure you choose will impact significant matters such as personal financial liability, tax considerations, the maximum number of business members, and costs related to the legal maintenance of the business.
The limited liability company (LLC) enjoys widespread popularity among entrepreneurs across all types of industries because it’s “hybrid” legal structure simultaneously offers liability protection while avoiding dreaded “double taxation” issues faced by C Corporations. However, while the LLC structure has the potential to offer considerable legal and financial benefits, it is also important for new business owners to familiarize themselves with the pros and cons of operating as an LLC.
The business formation attorneys of Bellatrix PC have extensive experience assisting entrepreneurs at all stages of their business, including LLC formation, the operation process, and business dissolution or sale of the business. At Bellatrix PC we are well-versed in California and federal laws governing limited liability companies. Whether you need assistance drafting enforceable LLC operating agreements, have questions about converting an LLC into a corporation, or simply need guidance pertaining to entity selection, our knowledgeable legal team is ready to help you meet your goals.
To learn more about how we can help your LLC succeed, call our law offices at (800) 449-8992 to set up a confidential legal consultation.
How LLCs Limit Personal Liability
The limited liability company does exactly what its name suggests, limits the personal financial liability of business owners should the business itself become liable for a debt.
While creditors may pursue funds held by the entity itself, individual members enjoy robust protection against the seizure of personal assets and other collection actions. In most instances, it is illegal for creditors to pursue vehicles, homes, or other possessions held personally by LLC members in order to satisfy debts arising from business transactions. This feature makes the LLC an attractive option compared with other entities which do not limit personal liability on behalf of the individual owners, such as general partnerships and sole proprietorships.
However, while LLCs generally restrict personal liability in the event of financial hardship experienced by the business, there are several situations in which members could still potentially be held personally liable for certain debts. Entrepreneurs must be made aware that even the LLC structure will not shield a member from assuming liability if he or she:
- Personally and directly causes personal injury and/or wrongful death, resulting in civil litigation.
- Makes a personal guarantee regarding debt repayment.
- Engages in fraudulent or otherwise illegal activities pertaining to the business, including but not limited to tax evasion, embezzlement, and employment tax fraud.
- Treats the LLC as an extension of his or her personal affairs, rather than as a separate legal entity.
Tax Obligations for Limited Liability Companies
In addition to limiting their personal liability, most entrepreneurs are equally concerned with minimizing their tax liabilities. The LLC structure can be ideal in this regard.
Like S Corporations (but not C Corporations), the LLC is what’s known as a “flow-through” or “pass-through” tax entity. This term derives from the fact that income which is generated by the LLC “passes through” the LLC itself to individual members thereof. Individual members report profits and losses on individual income tax returns, thereby avoiding the double-taxation applicable to C Corporations. Unlike their pass-through counterparts, the LLC and the S Corporation, C Corporations are effectively taxed twice: first at the corporate level, and then again at the level of the individual shareholders.
While they are both pass-through entities for tax purposes, the LLC enjoys several practical advantages over the S Corporation. To provide just a few examples, LLCs are generally simpler and less costly to form than S Corps, and can have an unlimited number of members.
Single-member LLCs have special tax considerations. The IRS designates single-member LLCs as “disregarded entities” for tax purposes, meaning profits and losses must be reported on the member’s Schedule C Form 1040 (Profit or Loss from Business) just as they would be for a sole proprietorship (in fact, Schedule C is expressly designed for use by sole proprietorships.) This special tax designation means it is unnecessary to file additional taxes for the LLC itself.
If you are forming a single-member LLC and do not wish to be treated as a disregarded entity, you may elect to be treated as a corporation by filing Form 8832 (Entity Classification Election) with the IRS. If you fail to file Form 8832, the IRS will simply use the default federal tax classification. Note that LLCs with two or more members can also request re-classification as a corporation by filing Form 8832.
If you are considering forming an LLC or other type of business entity, it is critical to seek legal guidance from an experienced business attorney. It is absolutely essential to provide a robust legal framework for your LLC during its formative stages to help put your new entity on the path toward success.
The attorneys of Bellatrix PC are prepared to help you navigate formation procedures and administrative requirements, draft company policies and operating agreements which comply with both state and federal laws, and most importantly, help you take all necessary legal measures to protect your bottom line so that your new entity can flourish and grow into the future.