An LLC, or limited liability company, is a business entity that has some properties of a corporation and other features of a partnership or sole proprietorship. Unlike a corporation, an LLC is a pure creation of the state. It is a hybrid organization in which its owners, known as members, can elect how the business is taxed.
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The Value of Limited Liability
An LLC offers the personal asset protection of a corporation. Should the company encounter operating, cash flow, or liability difficulties, creditors have no recourse to attack the personal assets -- homes, autos, bank or investment accounts -- of the members. This is the primary feature of an LLC.
Income Tax Components
Although an LLC is defined as a "non-corporate" entity, it is similar to an S corporation in that it is a "pass through" organization. This means the LLC profits are not directly taxed. Actually, the IRS does not recognize an LLC as a classification for federal tax purposes. An LLC must choose taxation as a corporation, partnership, or a sole proprietorship -- if the LLC is a "one-member" entity.
Important Legal History
Although some foreign countries have embraced the LLC for a long time, LLCs are relatively new to the United States. Further compounding the delay in U.S. legislation was the uncertainty of how the IRS would treat an LLC, should a state legally define and permit its existence. Not until 1977, when Wyoming enacted the first state legislation to permit LLC formation, was this structure defined in America. Followed by Florida in 1982, LLCs still posed a dilemma for the IRS. Finally, in 1988, the IRS, although not recognizing an LLC as a separate legal entity, issued a ruling that these companies would be taxed as partnerships. Remaining U.S. states quickly followed with legislation legally defining and permitting LLCs to exist.
Why LLCs Are Attractive
Prior to the creation of LLCs, smaller companies, partnerships, and sole proprietors had no way to protect an owner's personal assets. They had to create a corporation with all the paperwork, tax rates and rules -- elected board of directors, regular meetings and election of management officers -- that apply to every corporation. LLCs eliminated these concerns. LLCs generally have all the benefits of a corporation when it comes to limiting the business owner’s liability, but they also have management flexibility, as well as tax benefits that give members a great deal of flexibility in allocating profits and losses.