Full Form of LLC – Limited Liability Company
The full form of LLC stands for Limited Liability Company. A Limited Liability Company is a combination of a partnership or sole proprietorship structure and a company structure that has evolved in the US, wherein, the liability of the owners or investors is limited either by the amount of stock they hold or by any other defined means. However, the income of such a company is considered to be the personal income of the owner.
Purpose of LLC
- Limited liability implies that the personal assets of the owners can’t be attached to pay off the debts of the company if the company’s assets are not sufficient. This makes an LLC similar to a private limited company.
- When the income is considered as personal income, it avoids double taxation because it is taxed only once in the hands of the owners and doesn’t get taxed at a corporate level. This feature is called pass-through taxation. This makes it similar to the partnership or proprietorship format.
Characteristics of LLC
The following are the characteristics –
#1 – Governed by State Legislature
The rules for forming an LLC vary from one state to another except for a few generic ones which are common for almost all states. The default rules of the state automatically apply to the LLC formed in a given state, unless otherwise specified in the formation documents and approved by the governing authority
#2 – Flexibility
LLCs are subject to lesser regulations and disclosure related requirements, therefore this structure provides a more flexible environment to work in. It is popular with smaller organizations to create this form of a structure due to restrictions of funds and manpower
#3 – Protection of Personal Assets
LLC provides greater protection to the personal assets of the owner as compared to a corporation format.
#4 – Fiduciary Duty
After the ruling in Delaware LLC Act, 2013 it was established that the owners have a Fiduciary duty towards the LLC and its members which implies that they have to act in the best interest of the LLC and its members. This is to protect the rights of the LLC from the ill intent of owners who would want to misuse the limited liability protection of this organization structure.
#5 – Operating Agreement
Similar to a partnership agreement, there is an operating agreement for an LLC to avoid a situation of disputes in the future and smooth running for a long period of time. Such an agreement contains the contribution made to the capital by the owners, the reward sharing ratio and the organization structure of the company.
#6 – Legal Registration
A state-specific registration is required for an LLC to start transacting, this somewhat similar to a certificate of commencement of business. Formation of the LLC is similar to receiving a certificate of incorporation but before the LLC can begin the business, it needs to register itself as per the guidelines of the state.
#7 – Taxation
If there is only one owner of an LLC, then it falls under a disregarded entity and is taxed as per the individual tax rate. The income or loss is specified in the Schedule C of individual tax returns. If there are multiple owners, it is taxed as per partnership taxation rules and the individuals mention the income as per the reward ratio specified in the operating agreement. However, an LLC has the option of registering itself as a corporation for taxation purposes if it feels this is appropriate.
How to Create an LLC?
The process is shown in the below smart art –
Let’s elaborate on these:
#1 – Naming of LLC
- An LLC should have the words ‘LLC’ written at the end of it, either in full form or an abbreviated form
- The chosen name should not be similar to that of another LLC in the given state
- It is advisable to reserve the name for a small fee till the time the registration of the LLC is not complete
#2 – Filing Articles of Organization
- Filed with the secretary of state in most states or any equivalent authority.
- It can also be known as the certificate of organization or formation.
- The LLC should abide by the state-specific requirements for such filing.
- Information such as name, name & address of the registered agent, name of managers and owners, etc. need to be filled in the articles.
- The payment of the state-specific fee is the final step of this process.
#3 – Choosing a Registered Agent
- The person entrusted with accepting legal notices on behalf of the LLC.
- Should have an address in the state where the LLC is being formed.
- It can be a member of the LLC or a commercial third party who renders such services to various LLC in the state.
#4 – Member & Management Determination
- Members take care of day to day operations while owners may only invest capital if the LLC is very large or its operations are spread out.
- It might be an owner-managed LLC as well in case of small operations.
#5 – Formulation of the Operating Agreement
- If this document doesn’t exist, then the state law applies to the LLC however, it is a better idea to have one to avoid disputes in the future.
#6 – Compliance
- Obtaining the license for conducting business.
- Completing tax-related formalities to define how the income will be taxed.
#7 – LLC Registration in Non-Resident State
- If an LLC plans to operate in multiple states, it needs to register itself in each of these states.
- To find an LLC company, we can go to the Secretary of state website of a particular state and go to the database of business entities. There we may search for the LLC company we want to know about or we may even do a keyword search.
- So for example, BLACK ROCK CITY LLC is listed in the state of California and falls under the jurisdiction of Nevada. It has been active since 30th November 1999 and its entity number is 199933510147.
- We can even look for its latest Statement of information to see whether there is any change in the basic information of the LLC. This particular LLC is in the business of event production and its registered agent is Ray Allen.
Limited Liability Company vs Limited Liability Corporation
- Paperwork Requirement – The most important reason for the formation of an LLC instead of a corporation is that the disclosure requirements are lower in the LLC as compared to a corporation.
- Taxation – As discussed above the LLC is a pass-through taxation entity while in a corporation format, the corporation files its own tax returns, not through the owners of the corporation. Therefore the income is taxed twice, once as that of the corporation and once in the hands of the owners when they receive dividends. There are some exceptions to this but most of the time, taxation relief is a big incentive for LLC formation.
- Cost – As there are lower disclosure requirements and other paperwork in an LLC, the cost associated with this is also reduced.
- Size of the Organization – LLC format is preferred when the size of the organization is smaller and the owners are no geographically scattered and can be held accountable for their actions. The corporation is more suitable for larger organizations with scattered ownership and divorce between management and ownership.
- Avoids Double Taxation – The pass-through taxation mechanism leads to taxation only in the returns of the owners and not in the returns of the LLC, therefore the income is taxed only once
- Faster Formation – As the paperwork requirement is lower, it can be quickly formulated
- Cost-Effective – The fees required at various stages of formation and operation are very modest and nominal and therefore it is highly cost-effective.
- Protection to Owners –The liability of owners is limited and their personal assets can’t be used to pay the liability of the LLC unless otherwise specified.
- Appropriate for Smaller Organizations – If the ownership is geographically scattered and the operations are vast, the LLC form might not be efficient enough.
- Misuse of Flexibility – As the regulatory requirements are lower, there are greater chances of fraud and the owners may not sustain their fiduciary duties to the LLC and its members.
So, overall we can say that the LLC is a form of organization that combines the benefits of both a partnership and corporation formats to provide greater flexibility to the owners and investors. If not abused, then it can be a boon to the economy because of the benefits of lower costs and quicker formation. This could help people gaining courage of starting on their own without having to shell out huge amounts in forms of fees and spending hours on paperwork.
It is a situation of the best of both worlds if it doesn’t get affected by ill-intent and the owners fulfill their fiduciary duties properly.
This has been a guide to the Full Form of LLC and its definition. Here we discuss how to create LLC, its characteristics, purpose along with an example, advantages and differences. You may refer to the following articles to learn more about finance –