Overview: Limited Liability Company
The Limited Liability Company (LLC) has become a powerful tool for accomplishing many asset protection goals. The LLC is the most versatile and convenient strategy for owning rental property, insulating Dangerous Assets, operating a business, and achieving an excellent level of financial privacy.
The LLC is no longer a new and untested legal entity. It is now recognized in all fifty states with well-established case law and statutes. The adoption of the LLC format began in Wyoming and Florida in the 1970s with approval in most other states shortly after that. The purpose of the LLC legislation is to allow individuals to create a legal entity that avoids many of the tax and business problems inherent in the corporate and partnership structure. The intent of the law is to allow individuals to conduct their financial and business affairs in an efficient and convenient manner without the restrictions, formalities, and liabilities associated with those other entities.
More particularly, the LLC provides the protection from liability of a corporation without the formalities of corporate minutes, bylaws, directors, and shareholders. In contrast to corporate law, which allows shareholders and officers to be individually sued if the corporate formalities are not followed, the LLC law specifically bars a lawsuit against a member solely because of a failure to follow these formalities. That is an important distinction which you should understand. As we discussed, the principle shareholders and officers of a corporation are routinely named as defendants in a lawsuit against the company—forcing them to incur attorney’s fees to defend themselves and rendering the corporate shield meaningless from a practical standpoint.
A primary goal of the LLC legislation was to change this result by clearly stating that the members and managers of the LLC could not be named in a lawsuit against the company. The new law was drawn specifically to provide a vehicle that would protect the owners from liability associated with the business—what the corporation was intended for but no longer accomplished in the modern litigation-prone era.
A number of exceptions to this general rule of limited liability are contained in the LLC legislation and in subsequent case law. California Corporations Code Section 171011 (b) provides:
“A member of a limited liability company shall be subject to liability under the common law governing alter ego liability and shall also be personally liable under a judgment of a court or for any debt, obligation, or liability of the limited liability company, whether that liability or obligation arises in contract, tort, or otherwise, under the same or similar circumstances and to the same extent as a shareholder of a corporation may be personally liable for any debt, obligation, or liability of the corporation; except that the failure to hold meetings of members or managers or the failure to observe formalities pertaining to the calling or conduct of meetings shall not be considered a factor tending to establish that a member or the members have alter ego or personal liability for any debt, obligation, or liability of the limited liability company where the articles of organization or operating agreement do not expressly require the holding of meetings of members or manager.”
The statute itself allows for a piercing of the corporate veil under a theory of “alter ego” or under any other theory that could be used against a corporate entity (other than a failure to maintain corporate formalities).
Besides this modestly enhanced liability protection, the LLC is also convenient to maintain. The owners are permitted to adopt flexible rules regarding the administration and operation of the business. For tax purposes, it is treated like a partnership. That means the LLC itself pays no income tax. All of the income and deductions flow through directly to the members and is reported on their personal tax returns. If the LLC has only a single member, the owner can elect to treat it for income tax purposes as a “disregarded entity.” No federal tax return is required, and the income and expenses are reported as a sole proprietorship on the personal return.
The bad news, for physicians and some other professionals, is that state law generally does not allow licensed professionals to operate their practice as an LLC. The liability shield available to business owners has not been extended to doctors—due to opposition primarily from the trial lawyers. Although the LLC may be useful as a tool in protecting business assets from lawsuits, it will not insulate the individual from the liability associated with a professional practice.