by A. South

Created on: February 02, 2009

An LLC, which stands for limited liability company, is a legal structure for businesses that melds the benefits of a sole proprietorship and the limited liability protection that is offered by forming a corporation.

With the exceptions to a few states, there is no limit to the number of owners (called members) of an LLC. Members can be corporations, other LLCs and/or foreign entities. In most states, individuals can also form LLCs.

Like a sole proprietorship, an LLC is a pass-through entity, meaning that all of the business's profits, losses, credits and deductions flow through to member's tax returns. This structure makes it possible for the owner to use losses to offset other income. This protection, however, only covers up to the amount the owner has invested (so you can't use a small investment to shelter a large amount of income.)

Unlike a corporation, in an LLC income can be distributed evenly among members.

When deciding your corporate structure, consider your tax burden as well as potential liabilities. It's also important to consider the future of your company. If you're planning a merger or going public in the future, an LLC is not the most advantageous option. However, if you plan on selling the business in the future, an LLC is the better option because buyers can structure the deal as a sale of assets, not a sale of corporate stock (for tax and liability reasons).

Check with your state's laws in terms of an LLC. In some states, LLC members cannot sell their portion of the business without the consent of the other members (unlike a corporation shareholder who may sell without any approval). Be sure your members are aware of limitations before joining the LLC.

Think about the potential end of the business as well. In the event that the business might one day dissolve, the IRS considers an LLC's assets to be the property of its members. Because of that structure, if the business is dissolved and the property is distributed to members, the IRS does not consider the dissolution a taxable event.

Limitations of the LLC:
Members of the LLC can't make separate designations for income earned as salary and passive income. All profits are subject to Social Security and Medicare taxes in addition to income taxes.

History of the LLC:
The LLC as a legal structure is a relatively new option for companies. Most states didn't recognize it as a legal structure until the mid-1990s. The LLC quickly gained popularity, though. Today, most lawyers recommend it as a legal structure for a business because it offers a higher level of flexibility without additional liability.

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