A limited liability company is basically a business structure that is applicable to private companies. This structure combines the aspects of corporations and partnerships. They get benefits from the taxation of partnerships and proprietorship. But they need to maintain the limited liability status of corporations.
Limited liability companies gained popularity in the late twentieth century and they isolate their owners from personal liabilities and pass them through taxation. A limited liability company basically creates as per the statute of the state in which it is formed. It is very much required that the founder members of the LLC should file a “certificate of organization” with the secretary of state indicating that it is a limited liability company.
Partnerships, as well as limited partnerships, can also convert themselves to LLCs. In that case, the partner’s previous liability will not be affected, but limited liability will be provided. Unlike corporations, LLCs do not have multiple investors or raise money from the public. Typical LLCs usually have only a few members who jointly run the firm.
Now below we will discuss the advantages and disadvantages of a limited liability company. But before that let us clearly understand the objectives of this form of a business organization with the help of an example.
Now suppose Sam, Paul and Harry want to start a business together but they don’t want to form a partnership. This is because if they form a partnership then in that case they will be personally responsible for the debts of the business. Though three of them know very well that a corporation has limited liability, yet they are not comfortable with so many clauses in a corporation.
Moreover in a corporation, they will not be able to manage everything on their own. Apart from that, there is also a problem of paying double tax on the earnings. Thus forming a limited liability company is the only solution that they have. This is because LLCs combine the benefits of the corporation as well as a partnership form of business.
An LLC business organization governs under state laws and its owners are referred to as its members. Unlike corporations, the members of an LLC are allowed to manage the company by themselves and they can get involved in every task of the company and also in everyday operations.
They don’t need to appoint any board of directors as well as any managers for managing any task of the company. The best thing about an LLC is that the owners are having full authority over the company and also enjoying the benefit of limited liability. A single member can start a limited liability company and later can add as many members as he wants, there is no limit.
Advantages of a Limited Liability Company
An LLC actually borrows this advantage from corporations. This is the main advantage of an LLC, it acts as a separate legal entity and safeguards its members from being personally affected by business obligations. Members of an LLC are not responsible personally for any kind of debts takes for business purposes. We will take the help of a simple example to understand this more clearly.
Example: Suppose a company is started by three friends Karan, Manish, and Nikhil and they take a certain amount of loan from a bank for investing in a project of their business. And in the future, if the project fails and the company doesn’t have sufficient money to repay the loan, the bank then can go to court and take legal action.
But in the case of an LLC, the bank at best can ask the three members to sell the assets of the business and repay the loan, but the bank cannot chase their personal properties. That is the main advantage of a liability firm, the court cannot ask the owners to personally pay off the loan taken for business purposes. Here their personal properties are absolutely safe, unlike a partnership or sole proprietorship. Hence forming an LLC is one of the smart goals examples.
2) Tax Advantage
As per law, the income of the LLC is considering as the income of its members. This means that the members of an LLC will not have to pay double taxation on business income as in the case of a corporation. The earnings of a business are first taxed as per corporate tax rate in the case of a corporation and after that in the hands of the partners in the form of personal income tax.
So if the company started by Karan, Manish and Nikhil make a profit of Rs.1,00,000, the company will not have to pay any amount of corporate tax on this income. Instead, the three members will have to pay personal tax as per the tax rate on their own income.
3) Flexibility of income distribution
In the case of a limited liability company, you will have the flexibility to distribute the profits of a business. So the income of any type of business under this form does not have to be divided equally in the ratio of the partners. For example, both the three members contributed equal capital initially, but later any one member puts more effort towards the business than others. The one who is giving more time and effort deserves the greater share of the profit and in an LLC form of business organization, the partners are free to share their business profit in the ratio they prefer. But this ratio should match with the Internal Revenue Service’s Rules on partnership distribution of income.
Thus we can say that it is easier to set up and run a limited liability company than corporations. The incorporation of a corporation is a costly procedure whereas to form a limited liability company you will just need to fill an article of association and also the draft of an operating agreement. So forming an LLC form of business organization is easier and advantageous.