Limited Liability Company Explained

The limited liability company (LLC) is a fairly new form of business entity in Massachusetts. Before 1996 this form of entity did not exist in our Commonwealth, although it existed in numerous states across the nation. The LLC represents a totally new form of entity, identical in some respects to the limited partnership and the corporation, but also very different.

When this new entity was first introduced it created great excitement and was considered a solution for every business-structuring problem. In fact, the LLC is a powerful tool. In many cases, it is the solution. However, the LLC has also proved unsuitable for a range of business transactions and situations.

The LLC is attractive because of it’s principal attributes: a single level of income tax and limited liability for investors. A properly organized LLC is classified as a partnership for tax purposes and not taxed at the entity level. Its members (similar to shareholders of a corporation) face only one level of income tax. Items of income, gain, loss, deduction and credit flow through to the members of the LLC. Unlike the tax treatment of an S corporation, this favorable tax treatment for LLC’s is not dependent on the identity of its members, and there is no upper limit on the number of members an LLC may have. Like corporations and limited partnerships, LLCs provide holders of their ownership interests with broad limits on liability. The limits on liability are independent of other relationships such holders may have to the LLC. Participation in the management of the LLC does not subject a member to general liability. A member of an LLC who is also a manager may still benefit from protection against contract and tort liability in circumstances where a limited partner would have general liability.

The LLC is also a flexible entity with centralized management. Its management is delegated to managers who may have different powers, rights and duties. In some “corporate” models, the LLC strongly resembles a corporation with the familiar operating advantages of the corporate form: in this case, a group of managers functions as a surrogate board of directors and other managers replace officers. Any or all of these managers may be members. In other models, the governance of the LLC is configured in a manner very similar to a limited partnership. Indeed, many early forms of LLC operating agreements merely replaced the general partner with a manager who was also a member, and replaced the limited partners with members. Membership interests can be issued in series or groups and may have very different attributes.

There is a price to be paid for these significant advantages: documentation for LLCs tend to be more elaborate and costly compared to corporate documents. Close attention must be paid to the default provisions of the Act, and clients must make informed choices to accept or reject these provisions. The filing fee alone is $500.00.

One must resist the temptation to equate the LLC and the corporation. The differences between the two forms are numerous and only begin with the fact that the LLC is taxed as a partnership. Under both the Act and the tax code, an LLC cannot have only one member, whereas a corporation can have a sole stockholder. Under the Act, a member has the right to resign from an LLC even in violation of its operating agreement and, if he or she is one of only two members, to deprive that LLC of its existence by resigning. By contrast, stockholders cannot “resign” from corporations, and most corporations enjoy perpetual life. Incentive stock options are not available as compensation tools for employees of LLCs because LLCs do not issue stock. There are numerous tax and other differences between LLCs and corporations.

The LLC is an exciting new form of business entity. However, before choosing such an entity, one must consult with counsel and determine if it is the best entity to fit your business needs.