The limited liability company (LLC) is an unincorporated business organization that combines (1) the limited liability protection previously afforded only to corporate shareholders and limited partners, and (2) the tax advantages and capital flexibility generally associated with partnerships. The owners of an LLC are referred to as "members" and may be individuals, corporations, partnerships, or other LLCs. Combining outstanding asset protection with flow through taxation and flexibility, the LLC is a very useful entity. The LLC is one of the best means for holding real estate and other appreciating assets (up to $250,000 in value).
An LLC is formed by filing "Articles of Organization" with the Secretary of State. All members of the LLC must also enter into an operating agreement to define their basic rights and responsibilities. Although oral agreements are permitted, the agreement should be in writing. Cost and complexity of the agreement is based on the nature and business of the LLC.
An LLC allows greater flexibility in structuring management and control than any other business form. Management may be structured like that of: (1) a general partnership- decentralized, democratic and informal; (2) a corporation- centralized management with officers and managers who act as a board of directors; or a (3) limited partnership- centralized management with a manager acting like a general partner and leaving the members with no right to remove the manager. An LLC can be either member-managed or manager-managed. Unless otherwise provided in the articles of organization, an LLC is member-managed. In a member-managed LLC, every member is an agent of the LLC. The members have all the rights and duties of managers as set forth in the Corporations Code.
The owners of an LLC are not personally liable for the debts of the LLC, since it has a legal existence separate from its members. LLC owners can, however, be held liable to third parties for tortious conduct. Additionally, using the same factors applicable to corporations, a court may "pierce the veil" of the LLC to impose personal liability. In order to reduce the likelihood of piercing, an operating agreement may expressly not require that the managers hold meetings. This will help negate failure to observe corporate formalities as a factor allowing piercing. This added protective measure is unavailable to corporations.
The economic interest in an LLC is transferable without member consent, but the right to participate in voting and manage and control is not.
Unless otherwise provided, an LLC is terminated by the death, retirement, resignation, expulsion, bankruptcy, or dissolution of a member unless a majority interest of the remaining members votes to continue the business. An operating agreement provision can easily provide the perpetual existence offered by the corporate form.
LLCs, like corporations and partnerships, are not ordinarily taxed on the receipt of capital contributions of cash, property or services by members. A contribution of cash in exchange for a membership interest in an LLC, shares of corporate stock, or an interest in a partnership will also not be considered a taxable event for the contributing party. If a partner or LLC member contributes services in return for an interest in profit, the interest is not taxable upon receipt. If, however, the partner or member receives a capital interest in the business in exchange for services, the partner or member has taxable income.
In terms of income, LLCs are generally treated as partnerships for federal income tax purposes. Unlike corporations, an LLC can act like a tax shelter. By electing pass-through treatment, new business owners are able to deduct any losses the company may experience during the start-up phase. For example, an owner can offset any business losses with income from passive activities such as real estate investing. "Special allocation" rules are also applicable to LLCs. This allows them to allocate profit, loss, deductions, and credits from the LLC to individual partners as they choose to provide in their operating agreement. The LLC also has the option of being taxed like a corporation.