The US Limited Liability Company
Compared to the US Corporation
Why are Limited Liability Companies so popular? It’s rare to introduce new types of entities in the US but legislation to create the first LLCs was enacted in Wyoming in the late 1980s. They were immediately recognized as solving a particular need and states quickly fell in line to enact their own version of LLC legislation. Puerto Rico was the last jurisdiction to join the club. You can now form an LLC or corporation in any state; the Limited Liability Laws are generally the same with only minor variations.
How popular are they? In the year 2012, Delaware witnessed a 2.9% growth in the number of corporations formed but a 10.8% growth in LLC formations.
There are similarities as well as many differences between LLCs and corporations. The primary similarity is that, as with the corporation, the owners (Members) are liable for the debts of the corporation only to the extent of their participation in the venture – in short, Members cannot be sued for company obligations beyond their investment. Just as with a corporation, someone planning to sue the LLC cannot pierce the corporate veil to attack the personal assets of the Members.Let’s discuss differences in nomenclature. A corporation is generally formed in a given state by the filing of Articles of Incorporation – also called Certificate of Incorporation and other state variants - signed by the Incorporator and setting forth the name of the company, the company purpose, stock structure (common, preferred, classes, etc.) and many other provisions. The owners are called shareholders and will generally be issued their shares after the filing of the Articles and the Organization meeting. A following document generally adopted by the Directors is the company Bylaws which specify procedures to be followed such as Holding Annual Meetings, issuance of stock, etc. The Bylaws are rarely filed with the Articles but may certainly be incorporated.
The identity of the shareholder(s) is rarely disclosed in the Articles. It is also rare to name the first Directors although some states do require this. The Directors will generally provide overall management of the company and will appoint Officers (President, Vice President, etc.)
The LLC, on the other hand, is formed by the filing of Articles of Organization with a given state, usually in the office of the Secretary of State responsible for corporations– also called Certificate of Organization or Articles of Formation – signed by the Organizer. It will also set forth company name and various required or desired provisions. It will rarely name the Members (again, comparable to shareholders) but may sometimes name the Manager (comparable to Director.) Note that many states will require that whether the entity is to be managed by a Manager (who may, but need not, be a Member) or by the Members, must be stipulated in the Articles.
As a rule, you’ll see that Articles of Organization are generally more succinct than Articles of Incorporation. The states have far fewer mandatory requirements for inclusion for LLCs than for corps. For corps, some states require that, if the entity is to indemnify Directors, that provision must be in the articles. In such a state, such requirements, if appropriate, should be included in Organization documents as well. Filing fees for an LLC are quite comparable to that for a corporation. Usually states charge in the $150 to $300 range for filing fees (a portion of which may be the annual franchise tax.)
One of the biggest differences between the two entities is flexibility. States regulate what compliance measures corporations must take – when to have shareholder meetings, cumulative voting, etc. It is customary and expected by the states that the LLC will adopt a Members Agreement – comparable to the Partnership Agreement in a partnership – and sometimes called an Operating Agreement – which stipulates how the company will be managed such as how voting will be conducted, how Membership units will be expressed, e.g. in units, percentages or dollars. The states are very terse in what must be included. The Agreement is not publicly filed and can run from a paragraph to hundreds of pages which allows for enormous flexibility based on needs.
Another major difference is tax treatment by the IRS. In general, an LLC may elect to be taxed as either a corporation or as a partnership. This is done on IRS Form 8832 – Entity Classification Election.
In brief, a corporation when created is a C Corporation and is subject to “double taxation”. It is taxed on net income after deduction of permissible expenses. If the corporation has made a profit and if approved by the Board, it may return some of its profits to the shareholders by means of a dividend. However, dividends, although paid from income which was already taxed, must also be included with, and taxed, to the shareholder herself, hence double taxation. If a corporation meets certain requirements such as maximum number of shareholders, and that all shareholders are US persons, it can elect to be taxed as an S Corporation – the entity files an “information return” and income and deductions are “passed-through” to be taxed at the shareholder level avoiding double taxation.
How are LLCs commonly used? One application is where the Members are domiciled in both the US and outside the US. In this case, an LLC can avoid the double taxation that would otherwise apply. Another scenario is where one or more Members are entities and “pass-through” taxation is desired.
In business real estate situations, accelerated depreciation is usually desirable. For rather abstract reasons, such deductions are permissible to an LLC (or C Corporation) but not to the standard S Corporation.
When non-US people or entities are involved with US persons in certain international situations and not doing business in the US, an LLC can be the perfect SPV (Special Purpose Vehicle); in this case, a tax neutral entity that can be inserted in certain structures. Delaware, because it never seeks to tax income earned outside its borders, is often used for SPVs.
Because disclosure requirements are not extensive for LLCs, the entity may be a wise choice where privacy considerations are paramount, such as serving as shareholder.
If the LLC does not do business in the US, has no US-source income and is owned entirely by US non-residents, the LLC may be a “de facto” but not “de jure” offshore vehicle. FBAR and FACTA considerations may apply.
Finally, LLCs generally have the full range of corporate solutions available to it. For example, certain states allow domestication and conversion provisions. For example, a Gibraltar corporation may convert to a domestic LLC within 24 hours in Delaware.
Because of the sparseness of compliance requirements, the LLC appears to have become the entity of choice for aspiring entrepreneurs.
In summary, where flexibility of management and compliance structure is needed or when “pass-through” taxation is wanted and not available under other structures, the Limited Liability Company may be strongly indicated.