The first limited liability company (LLC) laws were passed in Wyoming in 1977 as a way to combine the limited liability protections afforded to corporations and the benefits of partnership pass-through taxation. Since 1977, all states have passed limited liability company statutes. It is now the dominant business entity form of new businesses.
Advantages of LLCs
The key advantage of the LLC is that all members received limited liability protections. Members are not personally liable to third parties for company obligations or for torts committed by other members or by the company (however, everyone is always liable for their own wrongful acts). For example, if you are a member of an LLC that manufactures strollers, you would likely not be found personally liable if a defective product caused an injury. However, this protection is not absolute.
For example, if you were the engineer that created a defective stroller, or it was your own negligence that caused the injury, you could still be held personally liable for any injuries that result.
Another major benefit of LLCs involves taxation. A single-member LLC is taxed as a sole proprietorship, meaning that all profits or losses are passed through to the owner. An LLC with two or more members may elect to be taxed as a partnership or corporation (including an S-corp). Almost all LLCs elect to be taxed as a partnership, allowing it to take advantage of pass-through taxation. If taxed as a partnership, the LLC itself does not pay any taxes. Rather, the company profits are "passed through" to the members, who then personally pay taxes on the profits allocated to them.
Students frequently wonder why an LLC would elect to be taxed as a corporation. The major reason involves companies where the members elect to "reinvest" all profits back into the LLC. In such situations, corporate tax only hits once - at the business level - rather than twice as it usually does (discussed in the next chapters). Because there are no distributions to members, there is no double-tax. Rather, the firm profits are only taxed once at the corporate tax rate, currently set at 21%. If this amount is less than the members' individual tax rate, you can see the appeal.
Yet another advantage of LLCs is the flexibility it affords businesses in the management of the company. Unlike corporations, formal annual meetings with detailed minutes are not required. Moreover, unlike S-corps, which require all owners to be U.S. citizen individuals, members of an LLC may consist of foreigners and/or entities.
An LLC is created according to the state law where the company is formed. Like shareholders in a corporation, the members (or as we call them in Idaho..."governors" ???) file an organizational document known as a Certificate of Organization. Many other states call this document the Articles of Organization. This document includes the name of the business, its principal address, the name and address of a registered agent, and the name of at least one member/governor. Idaho now permits the filing of this document online. To do so, start at www.sos.idaho.gov. From the Business Services drop-down menu, select Business Filings. From there, you can search Idaho business names to ensure that the name you desire is not already in use. Assuming it is not, you can then select Start a Business and fill out the form online. You pay a $100 fee online and then wait approximately a week for the state to publish your business on the Idaho database.
Though not required by the state, it is important to write out an operating agreement. Unlike the Certificate of Organization which has very little information and is available to the public, the operating agreement is typically very detailed and held internally. It will list all of the members/governors, how the voting and financial units are allocated, how the company will be managed, when meetings will take place, what matters require approval by the members, liability issues, dissociation procedures, etc. This document is the LLC's version of a partnership's partnership agreement, or a corporation’s bylaws. Unless otherwise stated, the operating agreement can only be amended by unanimous vote of all members. I'll provide you with both a simple and a more complex operating agreement form that you can review.
Management and Compensation
LLC members have two options for managing the company. It can be either a member-managed or manager-managed LLC. Unless agreed to in the operating agreement, the LLC will be assumed to be a member-managed LLC. If an LLC is member-managed, all members have actual and apparent authority to bind the LLC to contracts. In such a situation, all members have a duty of care and fiduciary duty to the company and to other members. If the company is manager-managed, only managers have authority to bind the firm and only they have the duty of care and fiduciary duties.
Distributions of profits are allocated among members of an LLC according to the operating agreement. Managing members (if any) may be paid for their services. Absent an agreement, distributions are allocated among members in proportion to the values of contributions made by them when the company was started. Upon a member's dissociation that does not cause dissolution of the LLC, the member has the right to be "bought out" by the remaining members.
When a member dissociates from an LLC, she or he loses the right to participate in the management of the company. The member no longer has a duty of loyalty to the company and the duty of care only survives with respect to events that occurred prior to the dissociation. Generally, the member is entitled to be bought out by the remaining members unless the member's dissociation causes the LLC to dissolve, in which case the assets are sold and all members receive their distributive share.
When an LLC is dissolved, the members who did not wrongfully dissociate may participate in the winding up process. To wind up the business, members collect, liquidate, and distribute the LLC's assets. Once all the LLC's assets have been sold, the proceeds are distributed to pay off debts to creditors first. The members' capital contributions are returned, and any remaining amounts are then distributed to members in equal shares or according to the operating agreement.