Legal Aspects of an LLC

by John Cromwell

A limited liability company is a relatively new form of business organization. A hybrid between a corporation and a partnership, LLCs are organized under state law. The laws regarding an LLC vary by state; there is no agreed on set of legal standards. However, there are some consistencies in how an LLC treated regardless of where the business is headquartered.

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Liability Protection

One of the key legal features of an LLC is that, like a corporation, it protects its owners from the liabilities and debts of the business. This means that if the LLC were unable to pay its outstanding financial obligations, the creditors cannot sue the owners of the business to make up the difference. But if a member cosigned a loan or voluntarily promised that he would pay any of the LLC’s obligations, he is no longer protected from those liabilities.

Piercing the Veil

Under certain circumstances the members of an LLC can be held responsible for the financial obligations of the business. Since the LLC normally acts as a partition between the members and the debts, when a member is found liable for the business’s debts it is called “piercing the veil.” If the members of the LLC misuse the business’s funds or use the LLC in a way that defrauds others, the members can be held personally liable for any of the LLC’s liabilities. Also, if the members do not make a reasonable initial investment in the business or attempt to observe the formalities of maintaining an LLC, such as keeping good financial records, the members can be held personally liable for the business’s liabilities.

Member vs. Manager-Managed

There are two types of LLC. A member-managed LLC is run by the members. Each member can enter into contracts on the LLC's behalf and can dictate how the business is run. A manager-managed LLC is run by select representatives. The members cannot enter into contracts on behalf of the LLC and cannot influence the day-to-day business of the LLC unless they were selected as a manager by the other members. Manager-managed LLCs are generally used when some of the members are meant to be passive investors or are unprepared to make business decisions.

Taxing LLCs

An LLC can be taxed as a partnership, corporation or sole proprietorship. If the LLC has only one member, it will generally be taxed as a sole proprietorship by default; if it has more than one member it will generally be taxed as a partnership. If the LLC is taxed as a sole proprietorship or partnership, the LLC itself is not taxed, but the business’s income and losses are divided amongst the members who include those on their personal returns.