The Basics of an LLC

The limited liability company (LLC) is a relatively new business entity. It was first used in Wyoming around 1975. It wasn’t until twenty years later that the LLC was recognized as a distinct business entity in all fifty states.

The LLC is a versatile business entity. It may be formed in a number of ways. It may also be taxed in different ways.

Manager-Managed Multi-Member LLC

Most LLCs have one or more members [owners] and one or more managers. An LLC formed in this manner is called a manager-managed multi-member LLC. In this LLC, the manager is the individual or entity which manages the LLC. The manager has total operational rights and responsibilities. The members may be described as passive investors. The members may have invested money or other assets into the LLC, but they have absolutely no managerial rights and responsibilities. In this type of LLC one or more members may also serve as the manager[s] of the LLC. In such a case, the members appointed as managers have the total operational rights and responsibilities and the remaining members are the passive investors.

Member-Managed LLC

An LLC may also be formed as a member-managed LLC. In this case all the members are appointed as managers. All the members therefore, will have equal managerial rights and responsibilities.

Single Member LLC

An LLC may also be formed as a single member LLC. One person or entity acts as both the sole member and manager of the LLC. No other parties are involved in the LLC. In most states, a single member LLC has the same asset protection characteristics as a multi-member LLC. However, in California and Colorado, the single member LLC does not have the asset protection characteristics of multi member LLCs formed in those states.

LLC Taxation

As mentioned, an LLC may be taxed in a variety of ways. When a method of taxation is chosen, the tax forms and all the laws, rules, regulations and statues for that type of entity also apply to the LLC. For instance, the LLC may be taxed as a “C” corporation. In this case the LLC will file a Federal IRS form 1120 or 1120A [corporate tax return form] and all the pretax business expenses which are statutorily available to a “C” corporation are also available to the LLC. Other ways in which an LLC may be taxed are as follows: An “S” corporation, a partnership, a sole proprietorship, or be formed as a single member LLC in which case the IRS has ruled that this is a disregarded entity and does not have to file any tax return at all.

Asset Protection

The LLC provides excellent asset protection, both for the people involved in the LLC and the LLC itself. If the LLC is sued and a judgment obtained, the judgment creditor can collect the judgment from the LLC. All assets of the LLC are at risk. However, if there are not sufficient assets in the LLC to satisfy the judgment, neither the members nor the managers of the LLC are liable for these debts or judgments. The judgment creditor may not attempt to collect any unsatisfied part of the judgment from either of these parties.

If a member of an LLC is sued and a judgment obtained, the judgment creditor is severely limited in his/her collection efforts against the LLC. The judgment creditor may not attempt to seize the assets of the LLC to satisfy the judgment. His/her judgment has been entered against a member of the LLC, and not the LLC itself. The LLC is a “person” under the law. It may hold assets in its own name, enter into contracts, sued and be sued and do all actions associated with conducting a business. Thus, its assets belong to the LLC and may not be directly used to satisfy the judgment against a member of the LLC. Nor may the judgment creditor obtain the ownership interests of the member as he/she can do in the case of a corporation. The judgment creditor is limited to a “charging order” against the LLC. This charging order requires the manager of the LLC to pay the share of the profits of the member who was sued to the judgment creditor instead of directly to the member. Once the judgment creditor has been paid off, he/she is out of the picture and the member has not had his/her ownership interest in the LLC affected. If the LLC is taxed as a partnership, there are additional negative consequences which may attach to the judgment creditor who obtains the charging order.