Limited Liability Company, popularly known as LLC, counts as one of the four organizational structures in the United States of America. It was first established in 1977 in Wyoming. It was followed by the state of Delaware which established this concept in 1991. You may have come across news reporting how a businessman went into debt and to cover for it, his assets were taken over. Here is something that we have to keep in mind. Business and owner are NOT independent entities.
In the eyes of the law, business and owner are one and the same, barring some exceptions. When the business is not making profit and is incurring heavy losses, debt is taken in the form of loan to make ends meet. When the situation gets out of hand, the entire business along with its goodwill is sold to recover from heavy debts. When the business is not enough, the owner’s personal assets like his/her property, cars, jewelry etc. are seized.
In this blog, we have focused on two organizational structures – LLC and LLP; and made a comparison of the two.
Limited Liability Company or LLC
LLC provides protection from this pitiful state. It provides protection to the managing members from the company’s liabilities. How is this protection provided? This organizational structure separates the personal assets of members from the professional assets of the business in order to make the company a completely separate entity from its owners. Thus, when creditors or other organizations file a lawsuit against your LLC, the authorities cannot come after a managing member’s personal assets. This special feature that sets LLC apart from other organizational structure should not be taken for granted. Even if an individual’s personal assets are not at stake, he/she is still accountable on the professional front.
Following are the main features of LLC:
- The main feature of this type of an organizational structure offers limited liability to the members of the company. Limited liability implies that the member’s personal assets are protected at all costs in case of debt covering.
- LLCs offer a lot of flexibility in tax filing. The taxes are essentially treated in the same manner as a sole proprietorship if the company elects for S Corporation. In case the company elects for C Corporation, the taxes are filed in a manner similar to partnerships.
- LLCs are governed by state laws which differ from area to area. According to some state laws, LLC may have to be dissolved upon the death or bankruptcy of a member.
- LLCs offer flexible membership. Members can range from individuals, partnerships to trust and estates.
- LLCs offer you dual benefits. It gives you the perks of a company but its working is easy and simple as a partnership.
Advantages of LLCs
- The biggest advantage of LLC is its main feature. Its ability to protect a member’s private assets like his property, cars etc. attracts many individuals.
- LLCs provide a great deal of taxing flexibility. The tax regime can either be like that of a sole proprietorship, a partnership, a company, S Corporation or a C Corporation.
- There is much less administrative and paperwork needed in maintaining an LLC, relatively speaking.
- In certain American states, an individual can find an LLC.
- Annual meetings and reports are not necessary in LLCs.
Disadvantages of LLCs
- The informal and rather easy approach of LLCs can discourage potential investors which may result in difficulty in fundraising.
- The startup cost can be more for an LLC is more than a sole proprietorship and a partnership which makes it more expensive.
- An LLC is not allowed to cash checks made out in its name. Checks must be deposited in a separate corporate account.
How to form an LLC?
- The first step to forming an LLC is to choose a state. LLCs are governed by state laws and for optimal benefit one must choose a state which has maximum favorable rules and regulations regarding LLC. For example, some states have norms stating that an LLC must dissolve with the death of a member. Such norms put members of LLC to a certain elevated level of disadvantage.
- The second step is to choose a name. Your LLC’s name should be very unique and one of its own to avoid confusion with other similar named companies.
- The third steps involve choosing a registered agent. A registered agent is someone who receives all the important legal notices and tax documents on behalf of an LLC.
- The fourth step involves the preparation of an operating agreement. There is no rule that an operating agreement should be written but an oral operating agreement is highly discouraged especially in multi membered LLCs. An operating agreement clearly states the division of ownership, labor and profits.
- Fifth step involves the process of making your LLC exist formally and legally.
- Applying for an Employer Identification Number (EIN) to the Internal Revenue Service (IRS) is the sixth step. This number serves as the LLC’s identification number which will be used on all its bank accounts, as well as income and employment tax filings.
- The next step is to open your business bank account through which all the transactions will take place.
After all these steps are completed, you can register in other states too if your business requires. This is an absolutely optional step.
In conclusion, LLCs have its own share of pros and cons. It depends on various external factors like the nature of business, availability of capital and labor, market behavior etc. to make a business successful.
Limited Liability Partnership or LLP
LLP is the short term for the Limited Liability Partnership. This is the perfect combination of the partnership with any kind of private limited organization. It was initially introduced in the year of
2000 using the Partnership Act 2000. This helped in providing the partnerships with already established companies to have the limited liability that is available.
Advantages of LLP
- In this case, no other separate legal unit has been established in this case which indicates that the losses or debts are not going to be blamed or taken responsible by all the partners. Instead, the partner due to whose acts it has happened is solely responsible.
- This has the complete continuous succession in it. Hence, any possible change in the list of partners won’t affect the LLP’s existence, rights or liabilities.
- In this case, the agreement terms are pretty simpler when compared to the other ones.
- There is no need of any kind of annual fillings for the partners, except their personal income tax returns.
Disadvantages of LLP
- There is a huge limit in the process when you wish to transfer your ownership.
- This doesn’t help you in giving a recognizable image like in the case of private limited company.
Difference between LLCs and LLPs
State laws for LLPs greatly vary from that of LLCs. States are independent and so laws vary when you move from one state to another. One must keep this point in mind at all times. As we know LLCs can be formed by any business, persons, or even an individual alone but the case is different when it comes to LLPs. LLPs are restricted to licensed professionals like attorneys, doctors, engineers, architects, and accountants.
Both LLCs and LLPs are not required to pay income taxes on its profits. Any profit earned or loss incurred is divided among the members according to the proportion stated in the operating agreement (LLC) or partners (LLP). On one hand where a single-member LLC is considered a sole proprietorship and has to pay self-employment taxes, the LLPs are treated strictly as partnerships and profits are passed straight through to the partners according to the proportion shared among them.
Administration and ease of use
In the case of LLCs, annual meetings and reports are not taken seriously. A one person founded LLC is very easy to handle with little paperwork and can be established very easily. If it is a multi-membered LLC a member must be voted at the end of every term.
LLPs on the other hand, involves professionals as partners. LLPs must be licensed with proper official qualifications. There is more administrative work and paperwork present, comparatively speaking. LLPs conduct regular annual meetings and carefully filed reports. Unlike LLCs, in LLPs partners can come and go according to their whims.
Both LLPs and LLCs are simple, easy on the hands organizational structures that are ideal for new small businesses and startups. Both business forms provide owners with personal liability protection, are relatively economical to establish and maintain and offer flexible membership structures. However, it’s clear that LLPs are best for practicing certain licensed professions while LLCs are better in most other situations.
Some states that are most favorable for setting up LLPs and LLCs are Delaware, Nevada and Wyoming. If you are planning to establish a startup or a new business, first take a look at your state law which governs the rules and regulations to first determine which entity is allowable and favorable in your state, as well as the state laws regarding personal liability for each entity.