Limited Liability Company (LLC)

A limited liability company, or LLC, is a type of legal entity which possesses characteristics similar to a corporation.  The LLC, is attractive to many business owners because it combines the limited liability feature of a corporation, the flexibility of a partnership and the pass through taxation afforded S Corporations.  As with most business entities, limited liability is a key benefit.  Like a shareholder in a corporation, an LLC member is not personally liable for the debts of the company beyond the value of their investment in the LLC.  This means that, if the LLC is sued, any damages recovered will be paid from the assets of the LLC and not from any individual member's personal assets (except in cases where a party is able to pierce the corporate veil).  

The formalities of operating an LLC are less involved than with a corporation.  While it is common for LLC operating agreements to call for annual meetings, they are not required under California law.  Often new and growing businesses lose track of the corporate formalities.  They forget (or put off) holding annual meetings.  In such cases, the company risks losing its corporate status.  Losing corporate status means losing liability protection for its owners.  Those forming California LLCs have the option of foregoing annual meetings and reducing this risk.   In addition, unlike the S Corporation (which has more rigid requirements relating to, among other things, a single class of stock, foreign ownership and the election of officers), the LLC allows its members to apportion income and voting rights as they see fit and to operate the company as member managers (much like partnerships). 

Finally, the LLC allows for pass-through taxation (as opposed to the double taxation of a C Corporation).  Pass-through taxation means that the LLC’s profits or losses are "passed through” to the LLC’s members, who in turn report the profits or losses as income on their personal tax returns.  This is preferable to corporate double taxation, where the profits are taxed at the corporate level and then again when shareholders receive dividends or distributions of profits.

A disadvantage of the California LLC is that it is subject to California's gross receipts tax (in addition to the personal taxation passed through to its members).  The gross receipts tax is an additional fee that LLC's must pay which is calculated based on the company’s gross revenues.  Because the amount of an LLC’s gross receipts tax is calculated on a sliding scale based on revenue (rather than profit), companies with high volume and a small profit margin need to think carefully about opting for the LLC.  Currently, California's gross receipts tax is calculated based on the following scale:

    $0 to $249,999 Gross Revenue = $0
    $250,000 to $499,999 Gross Revenue = $900
    $500,000 to $999,999 Gross Revenue =$2,500
    $1,000,000 to $4,999,999 Gross Revenue = $6,000
    $5,000,000+ Gross Revenue = $11,790

In California, the LLC is formed by the filing of Articles of Organization, Form LLC-1, with the office of the California Secretary of State.  California law requires that all LLC’s appoint an individual to act as the registered agent for the company.  The agent is an individual or corporation that agrees to accept service of process, or legal papers, on the LLC’s behalf.  While not required, it is also advisable to adopt an Operating Agreement addressing important issues like management, allocation of profits and losses, capital contributions, dissolution, death, incapacitation or bankruptcy of a member and the sale of a membership interest to third parties. 

If you have questions about forming a California Limited Liability Company, please contact San Diego Corporate Lawyer Donald R. Oder at (888) 900-9002.