Limited liability companies are small businesses with the operating flexibility of a partnership and some of the financial protections of a corporation. They have existed since the 1970s and have become a popular choice for small businesspeople and entrepreneurs. An LLC can be created online from home, but the cost and paperwork required varies from state to state.
Creation of the State
The concept of a limited liability company is not a creation of the Internal Revenue Service. Instead, it was developed by individual states in order to provide a greater level of protection to entrepreneurs and small businesses. As a result, the precise rules for LLCs depend on which state they are registered in.
Limited liability companies provide protection for their members from the company's debts; hence the term “limited liability.” When an LLC goes bankrupt, the members' personal liability for its debts is generally capped at the amount of money they have already put into the business.
Piercing the Veil
In situations such as the irresponsible use of an LLC's limited liability to avoid payment of a personal debt, the courts have the power to rule that one or more of a limited liability company's members are personally liable for some or all of the company's debt. This is known as “piercing the veil" of limited-liability protection and serves to restrict the benefit an LLC provides to those who act responsibly. This area of law is generally unsettled and situations in which courts have held members personally liable vary by state and situation.
Because the IRS had no hand in creating the LLC as a form of company, there is no separate system of federal taxation for LLCs. Instead, an LLC is taxed as if it were a sole proprietorship, a partnership or a corporation. In general, a single-member LLC will be taxed as a sole proprietor and a multi-member LLC as a partnership unless they request corporate taxation using Form 8832.