Reasons for Setting Up an LLC

by Jeff Franco J.D./M.A./M.B.A.

Utilizing a limited liability company as the legal structure for your business may provide you benefits that are unavailable with other business entity structures such as a corporation. However, what some may view as a benefit, others may view as a drawback. Before choosing to form an LLC, you must evaluate what your particular business needs are and determine if an LLC structure is conducive to fulfilling those needs.

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Ease of Formation

Most states employ similar regulations for LLC formation. Most jurisdictions require a prospective owner, who will be known as a member, of the LLC or an organizer to draft the articles of organization and deliver the paperwork to the office of the secretary of state, or equivalent office. The articles of organization require the name of the LLC, an address for its initial office and the name and address of the person designated as the registered agent. The purpose of an agent is to establish a single mailing address for the receipt of all legal documents such as a complaint for a potential lawsuit. You may deliver the articles before a single member of the LLC exists, provided you anticipate a member joining the LLC within 90 days of its delivery. Otherwise, the certificate will lapse and the secretary of state will not file it.

Liability

Many entrepreneurs choose an LLC structure because of the limitations on personal liabilities it provides to members. As an entity separate from its members, the LLC has the ability to enter into contracts and obtain credit. In the event that the business is unable to meet these obligations, the members are not accountable for providing a delinquent payment or to stand in the shoes of the LLC to fulfill a contract. For example, if the business defaults on loan payments, the lender’s only recourse is against the earnings and assets of the LLC. This indirectly affects members in that they can lose the contributions to the LLC; however, this is the maximum that a member risks.

Lack of Transferability

You are unable to transfer membership to another person unless the operating agreement allows for such transfer. However, you can assign your financial interest in the LLC to another individual. The assignee then has a rightful claim to the profits you would receive, but does not have any authority to participate in LLC activities. This restriction may serve a business purpose to LLC members who want to ensure that control remains with the original members. In contrast to a corporate structure, when a shareholder sells a share of the company, all ownership interests in the share transfer to the new owner including the right to vote on business matters.

Taxation Flexibility

Members may choose the LLC structure because of the flexibility it provides in dealings with the Internal Revenue Service. The IRS designates an LLC as either a sole proprietorship or partnership for tax purposes immediately upon formation. However, the members may elect corporate tax treatment by filing IRS Form 8832. This election is binding for 60 months, at which time you can change back to a sole proprietorship or partnership. Corporate taxation requires the LLC to file and pay taxes separate and apart from its members, whereas partnership and sole proprietorship taxation require members to make tax payments on their respective share of profits.