Menlo park Business Lawyer Answers, “What is an LLC?”

Limited Liability Companies, or LLCs, have been an available business form in California since 1996, but despite being around for so long, a lot of people don’t really understand what an LLC is, and whether it is an appropriate way to organize their business.

Before LLCs became available, the most popular traditional business forms in California were corporations and partnerships.  Corporations have the huge advantage that the owner is not personally liable for the actions of the company–that is, the owner has limited liability.  However, every corporation is required to have the same structure that a Fortune 500 company has: there are stockholders who elect a Board of Directors to control the company, and the Board appoints officers (at a minimum, a President/CEO, Secretary, and Treasurer/CFO) to run the day-to-day operations.  Annual meetings and recordkeeping are also required.

Partnerships are much simpler to operate than corporations, and can be structured in any way that the people involved find matches their business operations.  However, partners are personally liable for all of the actions of the partnership.

The LLC was designed to be a hybrid form between a corporation and a partnership.  Most importantly (as the name implies), it provides the limited liability that the corporate form has.  However, an LLC does not have the same structural requirements as a corporation.  In fact, while the LLC Act has some default provisions, you are relatively free to organize your LLC as you see fit.  Some have Officers and Directors like a corporation, while others simply have a single person (usually called a Manager) who does everything.

Another advantage of the LLC form is that, in most cases, you can elect how the LLC will be taxed.  Corporations are ordinarily a separate taxable entity, which means you pay income tax when the corporation makes money, then the shareholders pay income tax again when they receive the corporation’s profits as dividends (a situation known as double taxation).  If you meet the IRS qualifications, you may be able to designate your corporation as an “S Corporation,” which avoids the double taxation.  Partnerships, on the other hand, always have pass-through taxation: the partnership’s profits and losses simply flow through to the partners’ 1040s.

An LLC can, in most cases, simply choose whether it will be taxed as a corporation, an S corporation, or a partnership, depending on which one results in the lowest overall tax.

While the LLC is a very popular and flexible form, it is not the right answer for all situations.  For example, certain types of businesses (mostly ones that require state licenses, such as attorneys, accountants, and so forth) are not allowed to use the LLC form.  However, for many of my clients, the LLC is the best combination of protection and flexibility.