Examining
the history of the Limited Liability Company (LLC)
This
article will be the first in a series of articles that discusses Limited
Liability Companies (LLC) and the benefits that a farm can obtain from
utilizing one or more LLCs. We will
first start my looking at the history of the LLC.
Starting
a few hundred years ago, if you wanted to create a legal entity to run a
business, you had two choices. First,
you could form a partnership. In general,
with partnerships all owners equally share control, profits, losses and
partnership property. Each partner has
the right to dissolve the firm and force the sale of its assets in the event of
a dispute. The benefit of a partnership
is that they are relatively easy to establish and have few formalities as far
as the yearly legal requirements. The
downside is that there is essentially unlimited risk to each of the partners
and the fact that if a partner wants out, such partner can usually force the
end of the partnership.
Conversely,
if a partnership was not desirable, a “C” corporation could be
established. In a corporation,
shareholders are not liable for any debts beyond their investment and a
shareholder generally lacks the power to cause the company to dissolve. The downside is that historically there has
been a double taxation being that distributions to owners are taxed as well as
the earnings of the corporation. In
addition, with a corporation comes more formalities as to yearly requirements
concerning meetings, shareholder notice, and so forth.
In the
second half of the last century, congress authorized “S” corporations which
allowed for partnership type taxation even though the entity was a
corporation. So, from a taxation
standpoint, things got a little bit better as to utilizing corporations as a
legal entity. However, there were, and still
are, certain limits with “S” corporations that many people find limiting and
undesirable.
A need
existed to have an entity that would give the liability protection of a
corporation along with the beneficial tax treatment and simplicity of a
partnership. In 1977, the state of Wyoming
answered the need and passed a limited liability company (LLC) statute and thus
the LLC was born. In as sense, the LLC combined the best of
partnerships and corporations. Some
people describe an LLC as a hybrid between a corporation and a partnership.
However,
the initial downside was that the IRS did not allow the LLC to be treated as a
partnership for tax treatment. In fact,
the IRS initially proposed treating LLCs as corporations. Thankfully, in 1988 the IRS decided that
Wyoming’s LLCs could be taxed a partnership.
Later on, the IRS determined that owners could use a “check the box”
format and decide whether they wanted their LLC to be taxed as a partnership or
corporation.
By
1996, every state had an LLC statute. Today,
the LLC is hands down the most popular legal entity of choice. The number of LLCs in the United States has
grown from a few thousand in 1993 to over 2 million today. Research shows that in some states the number
of new LLCs each year accounts for 90% of all new businesses established.
In the
grand scheme of things, the LLC is still considered a relatively new type of
legal entity, even though it first came into existence more than 40 years
ago. This is because it often takes a
great amount of time for the tax laws to adapt to a new entity, for case law
from courts to be established, and so forth.
However, with over 40 years of existence, a certain degree of “tried and
true” now exists with LLCs.
For farmers, utilizing an LLC over other forms of legal
entities makes sense. The LLC gives
liability protection, flexible tax treatment, and many other benefits, of
which, we will discuss in more detail in our next article.
John J. Schwarz,
II, is a lifelong farmer and has been an agricultural law attorney for 12
years. He can be reached at 260-351-4440, john@schwarzlawoffice.com, or visit him
at www.farmlegacy.com.
These articles are for general informational purposes only and do not constitute an attorney-client relationship.
