The Development of the Limited Liability Company

The legislatures of most states have enacted laws in the last quarter of a century authorizing a legal entity known as a limited liability company (LLC). The motivation behind the creation of this business form was a desire for simplification, coupled with a need to retain the protections from liability that are part of the corporate form. A limited liability company strikes a balance between the legal forms of a partnership or sole proprietorship and a corporation.

The Characteristics of an LLC

Before the creation of the concept of an LLC, persons seeking to set up a business had the option of creating a sole proprietorship, a partnership or some form of a corporation. Sole proprietorships and partnerships were relatively easy to set up, but provided little protection from liability. Corporations created a separate legal entity that could shield owners from legal claims, but also required the formation of a board of directors, the conducting of annual meetings, the preparation and issuance of shares of stock, the creation of a set of by-laws, and extensive annual reporting. In addition, certain types of corporations are subject to “double taxation,” paying a corporate tax on earnings, and distributing taxable dividends to shareholders.

The LLC still entails filing articles with the state, but generally does not require annual meetings, issuance of stock, or most annual business filings. Owners are not referred to as shareholders, but as members. The parties can allocate ownership in any percentage agreed-upon, pursuant to an operating agreement. In addition, all income distributed by an LLC passes through the LLC and is taxed only as personal income to a member. Most states require at least two members to form an LLC, but an individual may establish an LLC in a small number of states.

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