A corporation, formed by filing articles of incorporation with the Secretary of State and governed under by-laws, normally provides its shareholders with a shield against creditors (whether lenders, suppliers, or tort judgment creditors) of the corporation, unless the shield could be "pierced" or the shareholders give personal guarantees. Generally, the assets of the shareholders outside the business cannot be attached by the corporation's creditors. Yet there is a tax price: a regular, or C corporation is subject to tax. Also, if the corporation operates at a net loss, the shareholders are not able to claim the loss on their own tax returns.
These shortcomings may be overcome, to some extent, in several ways. A closely held corporation might pay out all of its earnings to its shareholders as salary or rent, thereby leaving no corporate income to be taxed. However, corporate losses would still be trapped in the corporation. Alternatively, the shareholders might make an election
These shortcomings may be overcome, to some extent, in several ways. A closely held corporation might pay out all of its earnings to its shareholders as salary or rent, thereby leaving no corporate income to be taxed. However, corporate losses would still be trapped in the corporation. Alternatively, the shareholders might make an election to become an S corporation. To qualify as an S corporation, the corporation must clear several tests. Only US citizens and resident aliens may be shareholders, the company cannot have more than 75 shareholders. Entities such as other corporations, partnerships, estates and trusts cannot be shareholders. Needless to say, this makes S corporations unavailable or unattractive in a wide variety of situations.
At the other end of the spectrum lie partnerships. In its most basic form, the general partnership, the income and losses of the partnership business flow through directly to the partners. However, all the partners are jointly liable for the debts of the partnership.
Of course, limited partnerships are employed to retain these tax benefits but reduce the liability of the partners. A Limited Partnership must have at least one general partner. with complete exposure for partnership debts and judgments. Everyone who is active in management, whether called a General Partner or not, is legally responsible for Partnership debts.
Limited Liability Companies
With LLCs, a hybrid form of business entity is at hand. Under the Illinois LLC Act, the members and managers are all shielded from the company's debts. Also, the Internal Revenue Service has ruled that an LLC will be treated as a partnership for tax purpose unless they elect voluntarily to be taxed as corporations. The election form to be filed is 8832.
Thus there is no longer a need to use a corporation or a limited partnership to provide liability protection and there is no need to live with the limitations of the S corporation in order to get partnership tax treatment
The limited liability company is one created by filing of Articles of Organization (similar to articles of incorporation) with the Secretary of State. The company does not have by-laws. It is governed by an Operating Agreement. The Operating Agreement is closer in form to a partnership agreement and may include terms like a shareholders' buy/sell agreement. The Operating Agreement sets the rules governing the company, such as the rules for conduct meetings, as well as the rights and responsibilities of the members and the company and between themselves. Thus, it states the members' understanding of who is responsible to contribute cash, other assets, formulae, machinery, etc. and how the income of the company will be distributed. It should address the various tax attributes of the company such as profits, losses, gains and credits, and under what circumstance the company will dissolve, among others. The Operating Agreement is not filed with any state agency
Doing Business in Other States
If the company is organized in a jurisdiction other than Illinois, or will be doing business in several jurisdictions, then the company must be authorized to do business as a foreign LLC in these other jurisdictions, much like corporations formed elsewhere have done for years. Every State in the Union, as well as the District of Columbia have LLC acts, and recognize LLCs formed in other states, just as foreign corporations are recognized. LLCs have existed in Europe since the late 1800s. In Germany, there are called Gesellschaft mit beschrankter Haftung (GmbH), in France, societe par actions simplifiee ( SARL).
Management of LLCs
It is up to the members to define in the Operating Agreement how the LLC will be managed. In some cases, the members might vest virtually all control of the LLC in one or a few managers (analogous to the officers and directors of a corporation or the general (managing) partner in a limited partnership). In other cases, the members might want a more active hand in company policy and day-to-day management, in which case the Agreement will provide for appropriate regular and organic vote percentages of members in a variety of circumstances.
Getting Out of an LLC - Dissociation
Under Illinois law, members of a Member-Managed LLC have a right to
withdraw from the company (dissociate) before the company is wound up, unless that right is denied in the Operating Agreement. Conversely, members of a Manager-Managed LLC do not have a right to dissociate, unless that right is granted in the Operating Agreement. In Delaware and some other states, there is no right of dissociation unless granted in the Operating Agreement.
Transfer of Interest in an LLC
The members may also provide in the Operating Agreement the rules governing when LLC interests may be transferred and which aspects of these interests may be transferred. These rules might include a right of first refusal for the remaining members. The "economic rights" of the members' interests might be freely transferable to an outsider, but the recipient of these rights might not be admitted as a full member, with full rights (like voting) of LLC membership, unless admitted by an affirmative vote of all or a significant percentage of the remaining members.
Creative Uses of LLCs
Except for banking and insurance, (prohibited activities under the Illinois LLC act) there is virtually no business enterprise for which an LLC would be inappropriate, except if the company is expected to be publicly traded, or if there are so many members of the LLCs that it could not legitimately be qualified for partnership tax treatment (unless of course partnership tax treatment was not desired). The Illinois Supreme Court has authorized LLC's to practice law. Medical and Dental LLCs must have only licensed members of their professions as members. Real estate, oil and gas ventures, any operating business, professionals, businesses with foreign investors, businesses seeking venture capital, and joint ventures between established enterprises, are just a few of the ventures that might benefit from doing business through an LLC.
Motorola chose the LLC form for Iridium LLC. Bill Gates used a single member LLC, to acquire his stake in Alaska Airlines.
LLCs for Estate and Asset Protection Planning
In the context of estate planning, where family limited partnerships are now being used, LLCs are providing an alternative outlet. Of particular interest in estate planning is the availability of "inside" basis adjustment due to step up in basis at death. Like a partnership, the basis of LLC assets themselves may be adjusted to reflect the step up in basis at death available for the decedent's share of the LLC assets. Finally, since outside creditors of LLC members typically can get only a charging order (like a garnishment) against that member's economic, interest, LLCs provide an excellent component in an asset protection plan. Unincorporated businesses can cause problems at the owners death. Ordinarily a probate court supervised proceeding is involved . On the other hand, the ownership of an LLC can be placed in a living trust, or registered in Joint Tenancy or "TOD," totally avoiding probate.
Whether one is best served by an LLC in any given situation, and how the LLC should be operated is a determination that depends on specific facts unique to each case. Competent and experienced counsel should be consulted before undertaking any business venture, particularly one as complicated and as poorly understood as Limited Liability Companies.
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