Ultimate LLC Compliance Guide. Michael Spadaccini
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require annual meetings and require fewer ongoing formalities.
• LLC owners are protected from personal liability for company debts and obligations.
• LLCs enjoy partnership-style, pass-through taxation, which is favorable to many small businesses.
Disadvantages of the limited liability company:
• LLCs do not have a reliable body of legal precedent to guide owners and managers, although LLC law is becoming more reliable as time passes.
• An LLC is not an appropriate vehicle for businesses seeking to eventually become public or seeking to raise money in the capital markets.
• LLCs are more expensive to set up than partnerships.
• LLCs must usually make periodic filings with the state and pay annual fees.
• Some states do not allow the organization of LLCs for certain professional vocations.
IS AN LLC A TYPE OF CORPORATION?
An interesting question I often hear is the following: “Is an LLC a type of corporation?” The answer is “No,” but LLCs bear some resemblance to corporations. First of all, a corporation is a state-chartered entity that is authorized by a state’s corporation law. LLCs are authorized to be formed by a different set of statutes, never by the same state law that authorizes the formation of a corporation. LLCs have their own separate statutes in all 50 states. Thus, in the eyes of the law, an LLC is a separate type of business organization and should not be confused with a corporation, despite many similarities between the two.
HOW LLCS ARE FORMED
LLCs are formed much like corporations. Both LLCs and corporations are chartered entities. This means that, unlike some types of partnerships that can be created without state registration, LLCs and corporations can be created only by filing a charter document in the state of organization or incorporation. An LLC’s charter document is called its articles of organization—a name obviously borrowed from the corporation’s articles of organization.
Articles of organization for LLCs are very similar to articles of organization for corporations. For example, both of them state the entity’s name, require the appointment of a “resident agent” (more on this below), and usually require a statement of purpose.
HOW LLCS ARE GOVERNED
LLCs can be governed in various ways; they are the most flexible types of business organizations in this respect.
Corporations, by statute, are required to be governed by representative management. In other words, corporations are governed by a board of directors who are elected by shareholders. (Close corporations are a partial exception to the rule of representative governance, but close corporation status is not available in all states and is hopelessly complicated.) A corporation’s directors may in turn delegate some of their powers and responsibilities to officers that they appoint.
General partnerships, on the other hand, are governed by their owners. The power and authority to operate and govern a general partnership fall upon the owners directly, without any representative management. The owners of a general partnership vote in proportion to their ownership interests.
LLCs can be governed either by direct management or by representative management. LLCs must always make an election to be governed by their owners (member-managed LLCs) or by an elected body or group of managers (manager-managed LLCs). A member-managed LLC is governed by its owners (members) equally, just like a general partnership. A manager-managed LLC is governed by one or more appointed managers. These managers need not be members of the LLC. A manager-managed LLC is managed much like a corporation, by an appointed body of persons other than the owners. The managers who undertake the governing responsibilities of an LLC can form a board or a committee.
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An LLC makes the election to be manager-managed or member-managed in either its articles of organization or its operating agreement. Some states dictate that the election to be manager-managed or member-managed be made in the articles of organization. Nevada is an example of a state where such an election is mandatory. Delaware, on the other hand, does not impose such an election.
If your LLC’s articles of organization do not require you to elect your form of management, you’ll make that election in your operating agreement. An operating agreement is a close equivalent of a corporation’s bylaws. Naturally, because a manager-managed LLC and a member-managed LLC are quite different, their operating agreements will differ greatly. LLC operating agreements cover matters such as who governs the LLC, how managers are appointed, how members can be ousted from the LLC, and such. Operating agreements, like bylaws, are not filed with the state. In fact, typically an LLC is not required to have any operating agreement in place, although it is advised. In the absence of an operating agreement, the LLC will follow the default rules of governance set forth in the laws of the state of organization. LLCs that operate without operating agreements are extremely rare. We discuss operating agreements in Chapter 3. In that chapter, we’ll also discuss the advantages and disadvantages of the two types of governance structure.
PROFESSIONAL LIMITED LIABILITY COMPANIES
Professional limited liability companies (PLLCs) are simply LLCs in which the members are engaged in rendering professional services, such as the practice of medicine or law. Forming a professional LLC is slightly more difficult than forming a standard LLC. Much like the shareholders of a professional corporation, the members of a professional LLC may enjoy personal liability protection for the acts of other members; however, each member remains liable for his or her own professional misconduct. State laws generally require professional LLCs to maintain generous insurance policies or cash reserves to pay claims brought against them.
Professional LLCs are not recognized in all states, most notably California. Professional LLCs are more sophisticated enterprises than standard LLCs, and their organization should be left to a qualified attorney.
LLCS VS. S CORPORATIONS
While both S corporations and LLCs provide limited liability and partnership-like taxation, they differ in significant ways, as shown in this table. There are other important differences, and legislation that makes S corporations more attractive to investors was passed by Congress in 1996. You should work closely with your tax advisor in choosing any entity for your business.
| S Corporation | LLC | |
|---|---|---|
| Owners (Number) | No more than 75. All shareholders must consent to the election at the time it is made. | No maximum and no minimum. All states allow single-member LLCs. |
| Owners (Eligibility) | Individuals, U.S. citizens and resident aliens, death estates, bankruptcy estates, and certain tax-exempt organizations. | All people and entities eligible to own S corporations plus corpora-tions, partnerships, most trusts, nonresident aliens, and pension plans. |