Limited Liability Companies: The 21st Century Business Entity

By Banks, Julia A. | Journal of Property Management, September-October 1994 | Go to article overview

Limited Liability Companies: The 21st Century Business Entity


Banks, Julia A., Journal of Property Management


The limited liability company (LLC) is fast becoming the preferred entity for many business owners, real estate investors, and developers.

A relatively new form of business entity, the limited liability company combine certain tax and non-tax advantages of corporations and partnerships. Like a corporation, an LLC offers limited liability for company owners. At the same time, its classification as a partnership for federal income tax purposes means that income is taxed only once, not twice as is the case with most corporations

The LLC concept originated in Germany in 1892 and later spread throughout Europ and Latin America. In 1977, Wyoming became the first state to adopt a statute for LLCs. Since IRS has favorably ruled that LLCs are taxed as partnerships, more than 30 states have enacted LLC statutes. Legislation is pending in almost all remaining jurisdictions. Each state's law is slightly different, and the IR considers each one independently. Therefore, it is important to ensure that you state's statute has been approved before considering the formation of an LLC.

Is it an LLC?

An LLC is classified and taxed as a partnership if it possesses two or fewer corporate characteristics. It is treated as a corporation if it possesses three or more corporate characteristics. The IRS has identified the four characteristics possessed by corporations as continuity of life, limited liability for owners, centralized management, and free transferability of owners' interests.

State LLC statutes may be either "bulletproof" or "flexible." A "bulletproof" statute is written to assure that an LLC will possess no more than two corporat characteristics (thus qualifying it to be treated as a partnership). For example, the Colorado Limited Liability Company Act is expressly designed to allow limited liability and centralized management, but imposes requirements that eliminate the other two corporate characteristics.

A flexible statute permits members to choose whether to be classified as a partnership or a corporation. This article will use the Colorado statute as a model for describing LLCs. Note that the exact filing procedures and limitation discussed here may vary from state to state.

Forming an LLC

An LLC is formed by filing "Articles of Organization" with the Secretary of State. The Colorado statute requires that an LLC's life may not exceed 30 years and that the name of the entity include the words "Limited Liability Company" o an acceptable abbreviation.

The owners of an LLC business entity are identified as "members." The day-to-da operating decisions are made by "managers," who are elected by the "members" to manage the company. A member may also be a manager.

The operating rules for the LLC and the rights and responsibilities of owners are specified in either the Articles of Organization or in a written "operating agreement." These agreements delineate the number of managers and apportion management responsibility or voting power among them.

Managers are elected at annual meetings and hold office for the term elected or until a successor is elected and qualified. Every manager is an agent for the LLC for the purpose of its business, and the act of every manager binds the LLC to any contract, including the contracting of debt.

Like other business entities, the LLC must appoint and maintain a registered agent within the state and file an appropriate annual report with the Secretary of State.

Colorado's statute prohibits LLCs from conducting business prohibited to limite partnerships. (This eliminates non-profit businesses, banks, and insurance entities that generally are not permitted to operate as LLCs.)

Why form an LLC?

LLCs are ideal for businesses of less than 100 employees and for real estate ventures for several reasons:

* The pass-through tax advantages of a partnership. Income is taxed to the individual owners when earned. …

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