A legal term of art created to describe a
limited liability company state statute that requires provisions in its
operating agreement that guarantee that the LLC will be treated as a
partnership for taxation purposes by the IRS.
2. Centralized Management
One of the four corporate characteristics.
Denotes management of the LLC by managers, similar to the officers and
directors of a corporation.
3. Check the Box
New term describing a new IRS ruling that permits LLC organizers to just select how they want the entity tax i.e. as a
partnership or a corporation so that organizers and the IRS will be able to
dispense with the drafting technicalities involved.
4. Continuity of Life
One of the four corporate characteristics. A
corporation has perpetual life. LLC's are usually set up to dissolve in 20-30
years because this is a corporate characteristic that is not essential and can
be circumvented by a vote of the members to continue the LLC for an additional
time period. LLC's, to receive the beneficial tax treatment of partnerships, can
only have two of the four corporate characteristics. The two that are usually
kept are limited liability and centralized management.
5. Corporation
A separate legal entity apart from its incorporators,
officers, directors, stockholders, or employees. It is strictly governed by
state statute.
6. Flexible
A legal term of art used to describe state LLC statutes
that permit the operating agreement to contain just about any provisions the
members want. If not drafted in compliance with IRS regulations the LLC will
not be taxed as a partnership but as a corporation. Most flexible state
statutes contain default provisions which means, if the operating agreement is
silent on a particular issue, the default rule will apply.
7. Free Transferability of Interests
One of four corporate
characteristics. Interests in the entity can be sold by the owner to anyone,
without the consent of the other owners. This characteristic is usually limited
in an LLC because of the closer relationship of the owners and because this is
one that can be eliminated and still keep the characteristics of limited
liability and centralized management. An LLC can only have two of the four
corporate characteristics and retain its right to partnership taxation
status.
8. Limited Liability
One of the four corporate characteristics. The
owners are only liable for their capital contributions. None of them are
personally liable for the business debts. This is the main corporate
characteristic that most business owners are seeking.
9. Operating Agreement
The agreement between the members of a limited
liability company that contains all of the operating details and methods for
making decisions etc. Tantamount to the bylaws of a corporation. Not all of the
states require a written operating agreement but, from a practical and prudent
standpoint, there should be one, especially considering the IRS regulations relative to partnership taxation.
10. Partnership
An association of two or more persons organized to conduct a
business for profit. It is not a separate entity apart from its owners or
partners. Each partner is liable for all of the business debts, not just
his/her proportionate share.
11. Partnership Tax Classification
An LLC will be taxed as a
partnership and not as a corporation if it only has two of the four corporation
characteristics. Partnership taxation is usually desirable because of certain
tax benefits available. Some of these benefits are:
Flow through taxation - no corporation double tax
Ability to deduct business loss on individual return
Basis for loss includes owner's share of company debt
Can increase basis by "step up" election
Can specially allocate items of income and expense
Can contribute and distribute appreciated property tax free
12. Sole Proprietorship
Oldest, simplest, and least complicated form
of doing business. Individual, sole owner makes all the decisions and has
absolute power. Personally responsible for performance of all contracts and no
protection from lawsuits etc. Personal assets that have no relation to the
business are at risk.
