Ashley has a JD degree and is an attorney. She has extensive experience as a prosecutor and legal writer, and she has taught and written various law courses.
Limited Liability Company
Many companies are structured as limited liability companies, or LLCs. The LLC is a newer business structure that provides several benefits to its members. LLCs are governed by the individual states and are recognized in all states. They are organized by filing with the appropriate state government office, though state laws regarding LLCs vary. In all states, an LLC is a combination of a partnership and a corporation, though it's technically neither. An LLC allows the pass-through taxation of a partnership with the limited liability of a corporation.
Note that the owners of the company are referred to as members. An LLC can usually be started with just one member, and there's no upper limit on the number of members an LLC may have. Unlike limited partners, LLC members can fully participate in everyday business operations while still enjoying limited liability.
Many well-known companies are structured as LLCs. For example, Anheuser-Busch, Blockbuster and Westinghouse are all organized as limited liability companies. Let's take a look at how LLCs work by looking at an example. Let's say that Ben, Bob and Brandi are starting a company. They'll be opening The Book Nook, LLC.
Limited liability companies, like The Book Nook, provide two main advantages, both of which come from other popular business structures. First, LLCs provide pass-through business profits like a partnership. This means that the LLC and business profits aren't separately taxed. The IRS doesn't treat the company as a separate tax entity. Instead, the profits flow through or pass through directly to the members. The business profits become the members' income. The members then file their own tax returns and pay income tax on their individual income.
For example, let's say that Ben, Bob and Brandi agree to split all business profits equally. The Book Nook makes $75,000 net profit in its first year. Ben takes $25,000 for his income, Bob takes $25,000 for his income and Brandi takes $25,000 for her income. The Book Nook won't pay taxes on its $75,000 profit. Instead, Ben, Bob and Brandi will each pay income taxes on their $25,000 shares.
Now let's turn to the second major advantage LLCs provide their members. LLCs provide full limited liability like a corporation. That sounds like an oxymoron, so let's take a closer look. Limited liability companies, like The Book Nook, allow their members full exemption from personal liability for business debts and obligations. This means that the company can only be held responsible up to the amount of the company's assets much like a business bankruptcy.
For example, let's say a book superstore opens right next door to The Book Nook. As a result, The Book Nook loses customers to the new store. Brandi manages the store and is several months behind in paying the store's rent and hasn't paid the bills for the last two shipments of books. In total, The Book Nook owes its creditors $50,000, and the creditors have filed lawsuits in an effort to collect. The creditors can only seek payment from The Book Nook itself and cannot collect more than they are owed. This means that none of the three members can be held personally responsible for any of the store's debt, though the store's assets can be liquidated in order to pay the $50,000 debt.
Keep in mind, however, that LLC members can still be held personally responsible for their own wrongdoings. For example, let's say Ben causes an accident on The Book Nook property, and a customer is injured. Ben will likely only have limited personal liability for that accident. If the customer sues The Book Nook, Ben can be held personally responsible for damages up to the amount he invested in the store. In other words, if Ben invested $20,000 in the store, then Ben can be held personally liable up to the amount of $20,000.
Let's review. A limited liability company, or LLC, is a newer business structure that allows the pass-through taxation of a partnership with the limited liability of a corporation. LLCs are recognized in all states and governed by individual state laws. As with a partnership, the LLC's business profits aren't separately taxed because the IRS doesn't treat the company as a separate tax entity. Instead, the business profits pass-through directly to the members. The profits become the members' income, and they then pay individual income tax on those profits.
Like a corporation, LLCs provide full limited personal liability to their members. This means that members have full exemption from personally liability for business debts and obligations. The company can only be held responsible up to the amount of the company's assets. Note, however, that members have only limited liability for their own wrongdoings that cause company obligations, such as court judgments. This means that a member can be held personally responsible up to the amount that member invested in the company.
After you have finished with this lesson, you'll be able to:
- Define limited liability company
- Identify the laws that govern the formation of limited liability companies
- Explain the two main advantages of limited liability companies
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