Date: October 2004

What follows is a general description of a Limited Liability Company (into which one can place assets such as real estate), briefly explaining how LLCs are created, what the goals and purposes of LLCs are, and some of the more basic characteristics of LLCs.

DESCRIPTION

A Limited Liability Company (LLC) is a noncorporate business entity formed pursuant to a state statute that provides owners protection against unlimited personal liability from creditors and third parties.  While other business entities also provide protection from creditors, an LLC possess the important characteristic of being a “pass-through” entity for federal (and in Idaho state) income tax purposes.  A “pass-through” is an entity in which all taxable revenues, expenses, gains and losses are passed through to the owners of the entity.  The owners, not the entity, are then responsible for the payment of the tax, if any.

(A)              Created by State Statue

An LLC is formed under, exists, and is governed by a state statue.  Generally, the state statute provides in detail how an LLC in that state is formed, registered, and terminated.  The statutes also provide that either (1) the LLC adopt Articles of Organization or an Operating Agreement; or (2) use the default provisions of the statute to determine the other issues, which affect the operation of the LLC.  Those other issues are numerous & are not addressed here.

(B)              The LLC’s Goal

States usually enact an LLC statue to create a business entity that accomplishes two specific goals.  The first goal is to provide owners and members of the LLC with limited personal liability.  The second is to confer upon the owners the preferential income tax treatment of a pass-through entity.

(1)               Limited Liability

The limited liability characteristic of the LLC is very straightforward: owners and members of the LLC are not liable for debts, obligations, and liabilities of the LLC.  However, an owner could be liable if that person guarantees or specifically accepts personal responsibility for the LLC’s debt, obligation, or liability.

(2)               Federal Pass-Through Tax Treatment

LLCs were created specifically to take advantage of the favorable federal tax treatment of a pass-through entity.  Under this type of treatment, an entity would not be taxed for any income it earned or generated.  Instead, all taxable revenues and expenses would be passed through to the owners of the entity who would then be responsible for the payment of the tax, if any, on those revenues and expenses.

In order for LLCs formed prior to the 1/1/93 to qualify for pass-through tax treatment, it must possess two or fewer corporate characteristics.

  • Continuity of Life
  • Free transferability of interest
  • Centralized management
  • Limited liability

For LLCs formed after January 1, 1997, a much simpler elective procedure is, applied.   LLCs are no longer subject to the four-factor test set forth above.  Instead, LLCs elect to be taxed either as a partnership or a corporation by filing a form with the I.R.S.

(3)               State Pass-Through Tax Treatment

Since states created the LLC to obtain favorable tax treatment, most LLCs, if they qualify for federal income tax pass-through treatment, will qualify for state income tax pass-through treatment. (Idaho, yes\ Washington, N/A)

(C)              Other Characteristics

(1)               Flexible Organizational Structure

An LLC can be a business entity with the flexibility to conduct its business affairs in the manner most advantageous for its owners.  State statutes require or allow an LLC to adopt Articles of Organization an Operating Agreement.  The Operating Agreement allows the owners to determine (within the confines of the LLC statue) how the LLC is to be organized, managed, controlled, financially structured (especially with respect to capital contributions, sharing of profits and losses, distributions, etc.) merged. Terminated, dissolved, and liquidated.

(2)        Membership

Generally, any individual, corporation, partnership (general or limited), trust, business trust, association, estate, or other LLC can be a member of an LLC

(D)       Fees

Fees will vary depending on who your advisors are, but the expenses at the state level are as follows:

Idaho                     No annual maintenance fee

Washington            $59 per yr – Secretary of State

(E)      Conclusion

In putting together this brief summary, I’m completely mindful of the fact that anyone contemplating the use of this type of entity should consult legal and accounting professionals as I did.  For my circumstances I formed numerous LLCs to slice up the liability pie as much as was thought to be reasonable.

One last thought: “1031 Exchanging & Practical LLC limitations” to be addressed next time.

Until next time,

Glenn Sather