Excerpt from Chapter 1
What a Limited Liability Company Is
A limited liability company (LLC) is a relatively recent invention. For hundreds of years, the three choices for a business entity were sole proprietorship, partnership, or corporation. However, in 1977, the LLC was invented by the state of Wyoming to fill a new need-businesses that wanted to be taxed and managed like partnerships but protected from liability like corporations. Once the Internal Revenue Service (IRS) accepted this arrangement, every state in the union followed suit and passed laws allowing LLCs.
The laws, however, were not identical and the effectiveness of the LLCs varied from state to state. In the beginning, singleperson businesses could not use them because the law stated that a sole person could not be taxed as a partnership. However, the IRS later changed the rules to allow single-person LLCs to pass through their income to the owner.
Because the early tax laws required two or more members to avoid corporate taxation, many state laws required two persons to start an LLC. However, after the tax law change, all fifty states now allow one-member LLCs.
Quick Tip
All fifty states now allow one-member LLCs.
In some states there are disadvantages to using LLCs, because the filing fees or annual fees are higher than for other types of businesses, such as an S corporation. Before forming your own LLC, you should compare the fees and requirements to be sure it offers your business the most advantages.
Legally, an LLC is a legal person, like a corporation, that is created under state law. As a person, an LLC has certain rights and obligations, such as the right to do business and the obligation to pay taxes. (Sometimes one hears of a law referring to natural persons. That is to differentiate actual people from corporations and LLCs, which are considered persons, but not natural persons.)
The idea behind both the LLC and the corporation is to allow people to invest in a new business but not risk unlimited personal liability.
Common Terms
Before forming an LLC, you should be familiar with the common terms that will be used in the text.
Member
A member is a person who owns an interest in a limited liability company, similar to the stockholder of a corporation. In an LLC, the members have the option of running the company themselves or having managers who are or are not members. Until recently, some states required an LLC to have two or more members, but now that the IRS allows favorable tax treatment for one-member LLCs, the states are changing their laws to allow them.
Manager
A manager is someone who runs the affairs of an LLC. In most states, an LLC can be either managed by all the members equally, or it can have a manager or managers who may or may not be members.
Managing Member
A managing member is a member of the LLC who runs the operations. If all of the members do not want to manage the LLC, then one or more of them can be designated managing member.
Registered Agent and Registered Office
The registered agent is the person designated by a limited liability company to receive legal papers that must be served on the company. (In a few states the term statutory agent is used.) The registered agent should be regularly available at the registered office of the corporation. The registered office can be the company offices or the office of the company's attorney, or whomever is the registered agent. At the time of registration, some states require the company to file a Certificate of Designation of Registered Agent/Registered Office. This contains a statement that must be signed by the registered agent that he or she understands the duties and responsibilities of the position.
Articles of Organization
The articles of organization is the document that is filed to start the limited liability company. (In a few states, it may have a slightly different name, such as certificate of organization.) In most cases it only needs to contain a few basic statements. More provisions can be added, but usually it is better to put such provisions in the membership agreement rather than the articles, because amendment of the latter is more complicated.
Operating Agreement
The operating agreement is the document that sets out rights and obligations of the members and the rules for running the company. An operating agreement is not required in every state, but having one is a good idea. If such an agreement has not been signed by the members, the rules provided in your state's statute apply.
Membership Operating Agreement
If the LLC is run by its members, the agreement is usually called a membership operating agreement. Even if the LLC has only one member, it is important to have an operating agreement to spell out the non-liability of the member for debts of the company.
Management Operating Agreement
If the LLC is to be managed by less than all the members, or by someone who is not a member, there should be a management agreement spelling out the rights and duties of the members and the managers. This can be combined into the operating agreement, in which case it would be called a management operating agreement.
Annual Report
Most states require some sort of annual report to keep the state updated on the members and status of the company. In most cases, the company will be dissolved if this form is not filed on time, and in some states, there is a very high fee to reinstate the company
