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Should You Be A Limited Liability Company?

By: Richard B. Pumilia

A limited liability company, or LLC, is a relatively new form of business entity available for use in California. The LLC will often be the "entity of choice" because it combines the best features of a corporation and a partnership.

Like a corporation, the owners of the LLC, called members, are not personally liable for the debts of the LLC.

For federal income tax purposes, if properly structured, LLCs are treated like partnerships. That is, the LLC is not a separate taxable entity, but rather all items of income and deduction "flow through" to the members, to be reported on their individual returns. This tax treatment is "pure" partnership tax treatment, unlike the treatment given to corporations which have made a Subchapter S election. LLCs are also not subject to the arcane restrictions applicable to S corporations respecting the number and nature of shareholders.

Like partnerships, LLCs enjoy much more flexibility than corporations in structuring the management of the LLC, which can be by all of the members, by some but not all of the members, or by non-member managers. Thus, the managerial structure can, depending on the needs and objectives of the members, vary widely.

LLCs, like partnerships, also enjoy much more flexibility than corporations in structuring financial arrangements between or among the members. An LLC, for example, might be an ideal choice for a deal where one member is putting in the money, and the other member is putting in services. LLCs avoid the arcane "one class of stock" rules which are applicable to S corporations.

To form a California LLC, a short document called Articles of Organization needs to be filed with the California Secretary of State. In addition, the members should enter into a written agreement called an Operating Agreement, which in many respects resembles a Partnership Agreement. The written Operating Agreement gets into the open each member's expectations; and in many cases the provisions of state law are varied in the Operating Agreement to suit the needs and objectives of the parties. One typical variation would be to provide that the LLC be required to distribute to its members cash in an amount at least equal to the income tax imposed on the members by the allocations of income made to the members.

The decision about whether a business should be a corporation (C or S), partnership, limited liability company, or other entity is important to the success of the business. The determination needs to be made on a case-by-case basis after consultation with an attorney and accountant experienced in the area.

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