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If a limited liability company sounds like a foreign concept, that's because it is.
For years, Germans, South Americans and the French were allowed to have small companies or groups of individuals who enjoyed limited personal liability while operating under partnership types of rules.
It wasn't until 1977 that Wyoming became the first U.S. state to enact LLC legislation. In 1982, Florida followed suit. Now, all states have made it legal, and it's the most popular structure, by far, for a small business. When LLCs finally hit these shores, the big question was whether the Internal Revenue Service was going to tax them as corporations or partnerships. The fuzzy picture came into focus in 1988 when the IRS agreed that an LLC formed under the Wyoming statute was eligible for partnership status. In 1997 the IRS eliminated a complicated series of regulations relating to LLCs. The IRS also gave LLC owners the option of electing corporate-tax treatment. These actions paved the way for more small businesses to elect to do business as LLCs. Most states also allow a sole proprietor to form an LLC.
There are four reasons behind the popularity of LLCs:
Limited liability. The LLC is the only entity (other than a corporation) that has limited liability. Owners are exempt from personal liability for business debts and other legal issues, such as court judgments.
Pass-through taxation. Profits and losses pass through the business and are taxed on the owners' individual tax returns.
Management flexibility. Owners are referred to as members. A member/owner can be an individual, a partnership or a corporation. Each investor/owner has a percentage interest in the LLC. This helps to determine how to split up profits and losses and divide voting rights.
Profit and loss distribution. LLC owners can decide how to distribute profits and losses among themselves. They are not required to divide profits so that they are proportional to capital contributions. They can be split in any manner.
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