Running a business can be risky. That’s why a lot of business owners operator through a corporate structure. They essentially use it to shield themselves from the liabilities of the business.
Historically, Kentucky business owners have used the for-profit corporation for their liability protection. But it may not be the best choice, especially for small business owners.
There are several disadvantages to using corporations. In some cases, both the corporation and its owners will have to pay income taxes on the same revenues.
Furthermore, owners can’t operate their business in accordance with their own rules. They have to comply with the same rigid rules that apply to all corporations. That can be a problem for some owners. A lot of those rules are designed for large businesses like General Motors and don’t work well with small firms.
Fortunately, there is an alternative to the corporation. In 1994, the Kentucky legislature created a new legal entity – the limited liability company – that provides the same liability protection as corporations.
The LLC has significant advantages over corporations. LLCs generally don’t have to comply with all the burdensome corporate and tax rules that apply to corporations.
The LLC was designated to allow owners to operate small businesses within a corporate structure but with far more flexibility. That makes the LLC a perfect fit for small business owners. In fact, substantially all small businesses are now structured as limited liability companies.
Some examples of LLC flexibility:
Taxes – LLCs don’t have to pay income taxes. Taxable profits and deductible losses are allocated to the owners according to their ownership interest. They can receive their share of the profits without being taxed at the LLC level. Yet owners can file a form with the Internal Revenue Service to designate the LLC as a corporation if they want it to be taxed.
Allocation of profits and losses – Owners can determine the allocation of LLC profits and losses based on each membership interest. They can also use an allocation more suitable to their specific needs. For example, losses can be allocated to a wealthy owners to use against income. Likewise, income can be allocated to less fortunate owners who need financial support. Allocation rights can be quite valuable to a family business.
Management – Owners can determine how the LLC business is managed. They can designate a manager and give him or her full authority over the LLC’s business affairs. Or they can choose themselves as managers or create a managing board or committee.
Protection from a member’s creditors – If a creditor executes upon an owner’s membership interest in a LLC, the creditor can only attach income attributable to that interest. The creditor is not entitled to sell a member’s interest or take the owner’s position in the LLC. A creditor can’t even offer an opinion on an LLC matter. Furthermore, the owners can agree to give the LLC and/or its owners the right to purchase an insolvent owner’s membership interest at a discount.
Like everything else in life, the LLC has its drawbacks, the biggest is ownership. A membership interest in an LLC is very similar to interest in a partnership. Like a partnership interest, a membership interest is not readily transferable. Usually an owner can’t transfer membership interest without approval of other members.
Also, if an owner wants to sell his interest, the LLC and other owners usually have the right to buy it at a set price. Owners can’t sell membership interests to non-member buyers or use the interests as collateral for loans. Once an owner acquires an interest in a LLC, he typically is stuck with it.
Overall, the LLC offers small business owners the best corporate structures under law. It gives them liability protection without interfering with their management of the business. What else could a business owner ask for?