Law Offices of Lisa C. Grimes

A Limited Liability Company is a legal business entity created under Chapter 347 of the Missouri Revised Statutes.  Limited Liability Companies are very popular among family owned and closely held business for two primary reasons:

(a)                The LLC provides its members with the limited liability given to shareholders in a corporation; and

(b)               The LLC provides for the pass-through tax treatment given to partnerships such that the income, profits, losses, deductions and credits are reported on the member’s personal tax returns.  A single-member LLC is a disregarded entity for tax purposes and does not file a separate tax return and all income, profits, losses deductions and credits are treated as those of the individual member.

The LLC also provides a great deal of flexibility in the management and operation of the company.

(a)                Articles of Organization – This document contains very basic information regarding the LLC, such as the duration, whether the LLC is manager or member managed and the name of the organizer and registered agent.

(b)               Operating Agreement – This agreement sets forth how the company will be governed and includes the rights and duties of the members and specifics regarding the operation and management of the company.  It also frequently identifies how the profits, losses, credits, income and deductions will be allocated among the members. 

(c)                Tax Identification Number – The IRS will assign a Tax ID number upon the formation of a new LLC. 

Differences from Corporations and Partnerships

(a)                Corporation -  A legal entity that raises capital by selling interest in the corporation (i.e. shares) to investors who then become shareholders and have the protection of limited liability in that as shareholders the are only at risk for the debts and obligations of the corporation up to the amount of money they invested to buy their shares.  This limited liability also generally applies to the officers and directors of the corporation, except with respect to tortious acts and omission personally committed by the officer or director.  In essence a corporation is an entity separate and apart from its owners and managers.  However, because it is viewed as a separate entity, distinct from its owners, it is subject to taxation.  Thus income earned by corporation is taxed at the corporate level and then any income distributed to the shareholder is taxed again at the shareholder level, as such the income of the corporation is subject to double taxation.  Corporations must also comply with significant legal and accounting rules. 

(b)               S-Corporation – A Subchapter S corporation is a corporation that has elected to be taxed under Subchapter S of the Internal Revenue Code,  which means that its is taxed as a partnership in that profits, losses, income, deductions and credits are reported on the shareholders personal tax returns.   While this in this way the LLC and S-Corp are alike, the S-Corp has a number of ownership restrictions and capital limitations. S-Corps can only issue on class of stock, they are limited as to the number of shareholders that they can have and only individuals, certain trusts and certain charities may be shareholders.  In addition, an LLC can have many classes of members and by doing so can provide for special allocations of profits, losses and deductions to its members depending on their class.  S-Corps must make pro-rata allocations due to the fact that only one-class of stock is permitted.

(c)                General and Limited Partnerships – While members of an LLC are taxed like a partnership and enjoy the same rights as limited partners, a limited partner cannot fully participate in the management of the business without risking the loss of it’s limited liability protection.  Further, all limited partnerships must have a general partner and the general partner does not enjoy limited liability protection, but is personally liable for the debts and obligations of the partnership and if there is more than one general partner the liability may be joint and several.    All members of the LLC are permitted to participate in the operation and management of the business of the LLC. 

Major Advantages

(a)                Limited Liability – Under most circumstances the members of an LLC will not be held liable for the debts and obligations of the company.  This feature is especially significant for the single member LLC, who without the LLC structure would be a sole proprietorship and not enjoy the limited liability protection afforded to a corporation and other business entities.

(i)                 In order to preserve the limited liability status, a member must take caution to execute all contracts in a way that clearly shows that the member is acting on behalf of the LLC or that he is the manager of the LLC. The LLC should also take steps to preserve the entity status of the LLC in order to protect the member’s individual assets from creditors.   In other words, the LLC should have a separate bank account, keep clear records of the business activities of the LLC by using appropriate accounting methods, properly capitalize the LLC and generally observe the corporate formalities which establish “separateness.”

(ii)                It is important to note, however, that membership in an LLC does not shield a member from personal liability for damage that results from the members own negligence, wrongful acts, omissions or other torts.  The LLC may also be liable for the wrong doing of a member, to the extent of its assets, if the member was acting within the scope of the LLC’s business.  A member can also be personally liable for the acts or omissions of employees or other members that are under the member’s direct supervision and control.

(b)               Management and Operational Flexibility – There are very few restrictions placed on the LLC with respect to its management structure.  There is no limit on the number of members or the classes of members and members may include individuals, trusts, partnerships, corporations and even foreign entities.  Moreover, all of the members may actively participate in the management of the LLC without losing their limited liability status.  An LLC can be member-managed or manager managed and the manager need not be a member.  If the LLC is manager-managed, the manager is vested with the exclusive authority to make management and business decisions on behalf of the LLC and the non-managing members will have no ability to make decisions or contract on behalf of the LLC except as specifically provide in the Operating Agreement.  If an LLC is member managed, each member has the authority to make decisions on behalf of the LLC and bind the LLC.  In addition, an LLC is able to structure its Operating Agreement to provide for special allocations of profits and losses among the members and these allocations do not necessarily have to be equal to the member’s proportionate interest in LLC.

(c)                Transferability of Membership Interests – An LLC allows members to maintain control of the day to day operations of the business even though “outsiders” may acquire interests in the company from other members.  An Operating Agreement will generally permit interests to be sold, assigned or transferred, however, the Operating Agreement is often structured so that the individual acquiring the membership interest via a transfer from an existing member will only acquire a financial interest in the LLC, giving the owner of the transferring member’s interest only the right to receive the distributions that would have been made to the old member and the right to share in the profits and losses of the LLC.  In most cases, the Operating Agreement will prevent the transferee of the member’s interest from becoming a member of the LLC and as such the transferee will not have the right to participate in the management of the LLC, vote on LLC matters or to inspect the books and records of the LLC unless, of course, the remaining member vote to make the transferee a member of the LLC. 

(d)               Asset Protection – Because a member can only transfer an economic interest in the LLC, the LLC operates as an effective asset protection vehicle.  A judgment creditor of a member, that is not also a creditor of the LLC, in essence, only has a lien against the member’s interest in the LLC which gives the creditor the right, in satisfaction of the judgment, to receive the distributions of the LLC which the member would have been entitled to receive.  An LLC, however, is not required to make distributions and consequently, if the LLC chooses not to make regular distributions, the lien of the judgment creditor may be of little use. 

(e)                Pass-Through Tax Treatment – An LLC may elect how it wishes to be treated for federal income tax purposes, but if it doesn’t make an election then a multi-member LLC will be taxed as a partnership and a single-member LLC will be treated as a disregarded entity.  In either of these cases there is then only one level of taxation because all income, profits, credits, losses and deductions pass through to the members.   

(f)                Capital Contributions – In most instances, contributions of appreciated or debt-encumbered property are nontaxable and no gain is realized or recognized when property is contributed in order to capitalize the LLC.  A member may be required to recognize ordinary income when exchanging services for his membership interest. 

(g)               Debt Financing or Assumption of Debt – Distributions of loan proceeds to the LLC members is a nontaxable event, as is the assumption a member’s debt by the LLC, to the extent that the debt remains allocated to that member. 

(a)                Self-employment Tax – There is uncertainty as to how LLC members are treated for the purposes of self-employment taxes, however, rental income generated by LLC property is not considered to be net earnings from self-employment.

(b)               Passive Activity Losses – Passive activity loss rules may restrict the amount of losses that LLC members may deduct.  These rules provide that activities from passive activities, for example rental activities, may only offset income from passive activities.

(c)                At-Risk Basis Limitations – Tax losses of individual LLC members may be claimed only to the extent that the member’s investment is at risk.