Business owners and Doctors are increasingly bombarded with a variety of asset protection information from different sources of varying skill and experience. One common tool that attorneys and non-attorney promoters alike often focus on is the limited liability company or “LLC.”
Unfortunately, because LLCs are relatively simple to create and maintain, they are routinely misused and over-sold, with promises that simply can’t be legally kept. As such, part of our ongoing discussion of asset protection must include the basics every consumer needs to understand before using an LLC for any purpose.
As always, this information is in general terms and is not fact specific to your situation, it also assumes that we are acting proactively against exposures that may occur in the future, that you have a legal right to manage and segregate. Finally, no asset protection strategy is license to commit harm and requires that you have taken steps to reasonably avoid any harm by implementing compliance, safety, and best practices policies in all areas, and that you have adequately insured against reasonably anticipatable risks. Asset protection is always a system and never a single-shot solution, even with an objectively “good” and well-proven tool like an LLC.
The Small Business Administration (SBA) of the U.S. government provides some excellent, consumer-friendly information on a variety of business and legal topics that I borrow from heavily below as an essential introduction.
1. What is an LLC?
An LLC is a hybrid type of formal legal structure that provides the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership. It can provide what I call two-way protection; it can protect the assets from the unrelated liability of the individual owner, and the owner from the internal liability the asset itself may create, like the liability associated with owning a rental home.
2. Who can own an LLC?
The LLC is highly flexible in this area. The “owners” of an LLC are referred to as “members.” Depending on the state, the members can consist of a single individual (one owner), two or more individuals, corporations, partnerships, or other LLCs.
3. How is an LLC created?
It’s more than just filling out a form and requires guidance on a variety of issues including where it is created, what it’s used for, and how it is run. First, “Articles of Organization” are filed at the appropriate local agency in accordance with laws of the state in which it is created. The articles of organization is a simple document that legitimizes your LLC and includes information like your business name, address for legal service of process and or place of business, and, in some states, the names of its members (more on this in our next discussion).Then, an “operating agreement” is created. Having an operating agreement is highly recommended for LLCs because it provides rules for the LLC’s finances, organization, and smooth operation. The operating agreement usually includes percentage of interests, allocation of profits and losses, member’s rights and responsibilities, and other provisions that will be vital if the LLC comes under external attack in the future or in the event of conflict between partners.
4. How are LLCs taxed?
Unlike shareholders in a corporation, LLCs are not taxed as a separate business entity. Instead, all profits and losses are “passed through” the business to each individual member of the LLC. LLC members report profits and losses on their personal federal tax returns, just like the owners of a partnership would. While the federal government does not tax income on an LLC, some states do. All LLCs must elect to file as a corporation, partnership, or sole proprietorship tax return and may be treated as S-corporations as well.
5. What Are the Advantages of an LLC?
They “limit liability. Members are protected from personal liability for business decisions or actions of the LLC. This means that if the LLC incurs debt or is sued, members’ personal assets are usually exempt. This is similar to the liability protections afforded to shareholders of a corporation. Keep in mind that limited liability means “limited” liability, not “no” liability. LLC members are not necessarily shielded from wrongful acts, including those of their employees.
They have simplified recordkeeping and profit sharing rules. Compared to an S-Corporation, there is less registration paperwork and there are smaller start-up costs. There are also fewer restrictions on profit sharing within an LLC, as members can create operating agreements that allow them to distribute profits as they see fit, equally or unequally, for instance, when members contribute different proportions of capital and sweat equity.