Everything you need to know about Limited Liability Companies
Limited Liability Companies
Thousands of businesses are created each year. Businesses are either structured as sole proprietorships, partnerships, limited liability companies, or corporations. The structure chosen for any business determines how taxes are paid, who owns the business, and who is liable for lawsuits if legal issues arise.
The Companies Act provides for different methods of forming and registering a company. There are different types of companies, all of which have different modes of operation. They include foreign companies, public companies, limited liability companies, companies limited by guarantees, companies limited by shares, and unlimited liability companies.
Among the first decisions you are required to make when starting a business venture is choosing the type of entity that best suits your needs. In most cases, many people either choose to form a limited liability company (LLC) or a corporation.
What’s a Limited Liability Company?
A limited liability company is a unique business structure specifically tailored for private companies. One of the main things that make limited liability companies stand out in prospective business owners' eyes is that it combines aspects of corporations and partnerships.
Many people prefer operating their businesses as limited liability companies because they are separate legal entities. In simple terms, separate legal entities are treated as individuals by law. They can sue or be sued, enter into a contract, and initiate proceedings to terminate contracts. They also have a tax identification number, and they can also open bank accounts in their names.
Types of limited liability companies
There are various types of limited liability companies. They include:
1. Single member LLC
For tax purposes, single members LLCs aren’t treated as separate legal entities from their members. LLCs incomes are included on the members’ tax returns.
2. Multi-member LLC
As the name suggests, multi-members LLCs have more than one member. For tax purposes, they are treated separate entities. Members enjoy pass through of losses and profits.
3. Non-profit LLC
These types of LLCs enjoy the tax privileges just like non-profit corporations do. They also enjoy protection from liability and the flexibility of partnerships. It is worth noting that not all states the registration and operation of non-profit LLCs.
4. PLLC (Professional limited liability company)
These types of LLCs are registered for providing professional services such as medical or legal services.
5. Series LLC
These are special limited liability companies which allow single LLCs to segregate their assets into entirely different series as a way of protecting such assets from creditors.
Main features of limited liability companies
- Separate legal entity
The most outstanding feature of a limited liability company is that it is a separate legal entity that creates a corporate veil. This feature gives limited liability company owners, also known as members, the “limited liability” status. This means that members of a company will not have personal liability, or they will not be responsible for the debts of a limited liability company. It is assumed that there is a “veil” between a limited liability company and its members which protects them. For this reason, the term “corporate veil” was coined.
So, how do limited liability companies protect your assets?
A good example of a limited liability company as a separate legal entity is when a company is forced by circumstances to declare bankruptcy. When this happens, members are not required to pay the company’s debts with their money. If a company’s assets aren’t enough to pay off its debts and liabilities, there is nothing much that the creditors can do to make the company’s members pay for the debt and liabilities of the limited liability company. The law considers such debts as the company’s debts and not as the members’ debts. As such, creditors cannot take the members’ assets and auction them in order to recover their losses.
- Pass-through taxation
A limited liability company can choose its preferred tax treatment option. It can adopt a C corporation, S corporation, partnership, or sole proprietorship tax regime. As such, a limited liability company is considered as a flow-through or a pass-through entity, as long as it doesn’t opt to be treated as a C corporation.
How limited liability companies are taxed
Flow-through entities' incomes are considered as the owners’ income. In other words, owners who invest in flow-through entities can avoid double taxation due to the flexibility offered by limited liability companies’ tax options. Double taxation occurs when income is taxed in the process of distributing it to shareholders as dividends. It also happens at the corporate level after a company’s income is distributed to its shareholders.
Limited liability company members are taxed at an individual capacity after their profits are distributed to them. In LLCs, there is no double taxation since the business isn’t taxed at the company level.
Companies that choice to be taxed as partnerships can distribute their income to members in different forms other than distributing the income in terms of ownership percentage. However, if a company chooses to use this method, members of the company must first agree about the issue in the operating agreement, which acts as the bylaws of a corporation.
The difference between limited liability companies and corporations
The management structure of LLCs and corporations vary to a great length. Not only can their members manage them, but any member of an LLC can act as its manager. An LLC can choose not to distinguish between the business manager and its owner. Such management flexibility is what makes LLCs favorable to entrepreneurs compared to corporations.
LLCs can either be “member-managed” or “manager-managed.” Owners of member-managed LLCs oversee the company’s daily operations. On the other hand, manager-managed LLCs have investors who sit on the sidelines without an active role in the company's daily operations.
The management structure of a corporation is quite different. All corporations have formal structures whereby a Board of Directors takes care of management responsibilities to generate profits for the shareholders who are assumed to be the owners of the corporation. A corporation's shareholders do not take part in daily decision-making and management duties.
2. Sale of interests
Corporations’ shareholders can freely transfer or sell their stock shares without consulting other shareholders. After such a transaction, the shareholder who bought stock shares from a fellow shareholder receives all the seller’s voting, financial, interests, and ownership rights. However, the shareholders may agree to restrict the transfer of shares.
On the other hand, LLC members can sell all their financial rights without restrictions. However, some rules require other members to give the green light to the sale of a member’s interests- this includes the right to take part in the LLC management. For a buyer to become a member of a limited liability company, approval by other members is also required unless stated otherwise by the LLC’s governing document.
In a corporation, its board of directors decide if and when dividends will be declared. Shareholders of a corporation cannot dictate if dividends will be paid. Upon dividend payment by a corporation, each holder receives an equal piece of the cake on a per-share basis.
When it comes to LLCs, members also have the right to receive dividends, commonly known as distributions. That said, members must approve dividends issuance unless their operating agreement prohibits the practice. Distributions are equally allocated according to the value of a member’s capital contribution.
Deciding if a limited liability company or a corporation is appropriate for your business can be a hard choice to make. The ultimate decision depends on factors such as the business’s long-term and short-term goals, the type of business, and the sources of financing, among other things. Making the best choice requires one to have a vast knowledge of how LLCs and corporates work, how they differ, and how they are alike.
Corporations and LLCs may differ when it comes to taxation. However, there are other ways in which they differ which don’t relate to taxation. To make a sound decision, make a consultation appointment with one of our experts to determine the best way forward for your business.