What is an LLC? Within the past 20 years, a new type of business and estate planning entity has been springing up across the land. The Limited Liability Company (LLC) has become a widely used organization which, incidentally, shares many of the characteristics of sole proprietorships, partnerships, corporations and trusts.
Traditionally, corporations have shielded shareholders from personal liability for corporate failures, mistakes and setbacks, but corporations have been required by law to comply with burdensome, expensive formalities.On the other hand, partnerships and sole pro-pri-e-tor-ships have offered partners and proprietors a simpler way of doing business, and a simpler way of reporting income tax, without all the corporate formalities, but they have not provided the shield of limited liability. With the LLC, the best of both worlds is available. Further, many estate planning problems can be avoided through the proper use of an LLC.
The LLC has its origins in the Limitada, a business entity popular in Central and South Amer-ica. Limitada members could enter into business ventures and limit their liability for the obligations and liabilities of the business. The idea spread north of the border and, in 1977, the Hamilton Brothers Oil Co. lobbied the Wyoming Legislature to pass a bill similar to, but improving on, the Limitada. Wyoming responded by passing the first Limited Liability Company act in 1977.
Interest in the LLC grew when, in 1988, the IRS issued a ruling which said that a Wyoming LLC would be treated as a partnership for federal tax purposes. For many businesses, partnership income taxation is more favorable than corporation income taxation.
Consequently, Colorado and Kansas passed LLC legislation in 1990, followed by Nevada, Texas, Utah and Virginia in 1991. Since 1992, almost every state has enacted LLC acts and tens of thousands of LLCs have been formed.
LLCs have come a long way since the late '70s and early '80s. Back then, many attorneys and accountants cautioned clients against forming LLCs because the limited liability and income-tax characteristics had not yet been upheld in the courts. Now, with about 20 years of "history" behind it, the LLC is now widely recommended by professional advisors as an efficient and effective business and estate planning tool.
Some of the uses of an LLC include corporate joint ventures, family businesses, start-up businesses, construction companies, technology and research ventures, real estate ventures and estate planning.
Here is an illustration of how the "limited liability" characteristic works. Suppose two brothers buy a backhoe and start a business digging swimming pools. On the advice of their attorney and accountant, they run the business as an LLC, and they proudly call it "We Dig It, LLC."
They file the necessary paperwork with the state, obtain a tax-ID number, print their business cards, invoices and checks, and they start digging holes. As an act of good faith, they also purchase a liability-insurance policy just in case one of their excavations caves in and hurts someone.
One day at the pool site a neighbor drops by to have a look and the excavation wall caves in on him and suffocates him. His family makes a claim against "We Dig It, LLC" and against the personal assets of the brothers. Believing that their insurance company will pay the family's claim, the brothers call their insurance agent but are told that their policy was recently canceled for non-payment of premium; one of the brothers forgot to mail the check.
If the failure to pay the premium was an honest mistake, the lawsuit against the brothers would probably be dismissed because the LLC shields them and their personal assets from liability. The lawsuit against the LLC would continue, however, to determine whether the LLC should or should not be liable for the death of the neighbor. Without the LLC, the brothers would be personally liable for all of the family's claims.
As mentioned above, the LLC has numerous uses, including estate planning.
As with all legal and tax decisions, be sure and contact an experienced attorney and accountant so that you can properly explore whether the LLC is an entity that will properly work for you.