One of the principal reasons entrepreneurs choose the limited liability company structure for a business is the protection from personal liability it offers owners from creditors of the LLC. Most jurisdictions impose liability for business obligations solely on the LLC. Although the standards are fairly uniform across jurisdictions, some variations may exist.
Debts and Obligations
Often it is the members who manage the business, enter into contracts and otherwise bind the LLC. When acting within the scope of their authority in the course of normal business operations, individual members are not personally liable in the event that the LLC defaults on a debt payment or breaches a contract. The other party may seek a court judgment that is enforceable against any and all business assets. As a result, the members are indirectly liable to the extent of the property and monetary contributions they make to the LLC.
A majority of states have adopted the Uniform Limited Liability Company Act and do not require an LLC to distribute its profits to owners. However, members may draft an operating agreement that makes the distribution of profits non-discretionary on the occurrence of certain events, such as when the LLC meets certain profit levels. The LLC is bound by the operating agreement and must make profit distribution payments when such events occur. If the person who has the authority to issue profit disbursements refuses to comply with the operating agreement, the LLC is liable to each member for the distribution. Affected members then have an enforceable legal claim against the LLC as a creditor.
As a separate legal entity, the LLC may hire nonmember employees to assist in the running of business operations. Most jurisdictions impose liability on the employer when an employee causes damage to other parties while conducting business activities and acting within the scope of their position within the company. However, the LLC is not liable for the intentional torts of the employee. For example, if an employee is responsible for making deliveries and causes an accident because of a blind spot in his side mirror, the LLC is responsible for damage to the other party. In contrast, the LLC may not be responsible if the employee uncharacteristically becomes angry and purposefully drives the car into a group of pedestrians.
The Internal Revenue Service treats all LLCs that have more than one member as a partnership, and single-owner LLCs as a sole proprietorship for income tax purposes. Other than the LLCs duty to file an informational partnership tax return, the responsibility for reporting the taxable income and making tax payments rests solely with its members. However, the members may make an election to treat the LLC as a C corporation for tax purposes by filing IRS Form 8832. Electing corporate tax status imposes all responsibility on the LLC to file an annual corporate tax return on IRS Form 1120 and pay the appropriate tax. Members need not report any of this income on a personal tax return.