Create An LLC
Maintain An LLC

I just realized I don’t believe I have ever written the history of the Limited Liability Company on this blog which is fairly significant to understand if you want to wrap your mind around the intricacies of the LLC.  It helps to understand the Limited Liability Company if you understand that it came about as an invention in response to a need.  For years business owners had been forced to choose between one of two options, namely a partnership or a corporation.  There were benefits to both entities, but both entities had serious draw backs.

Benefits and drawbacks of the corporation:
The corporation provided corporate veil protection, which protected shareholders assets, but for a small closely held corporation, the corporate tax model was cumbersome. The lack of barriers keeping out unwanted shareholders if another shareholder was sued also made the corporation a drawback. Corporate shares were really too alienable or transferable for small corporations.

Partnership Problems
The partnership was easy to form and easy to operate. In reality, any two people coming together to work jointly became a partnership, and without doing anything, the business was protected by the state charging order statutes. The tax structure for a partnership was also simple. Partnerships are taxed under the IRS schedule K. All income from the entity is treated as though it flows through in proportion to the owners. The problem with the partnership was that all liability also flowed through to the owners. Even with a limited liability partnership, there was always a general partner who took the full brunt. If any limited partners engaged in the management of the business in anyway, they could be said to lose their limited liability protection. Also, sole proprietors who were not going into business with anyone had only the corporation to choose from.

Judicial Imposition of Fiduciary Duties
Another problem that set the stage for the LLC was the long standing judicial imposition of Fiduciary Duties.  Over the course of many years, judges had decided that the statutes that governed partnerships and corporations had holes in them and did not deal with certain situations well.  To address these “holes” in the statutes, the judges imposed fiduciary or required duties that one party owed another.  Many business owners were tired of these unasked for burdens, and wanted a legal entity where they could control everything by contract.  Business owners wanted to be able to set all terms of their relationships as business partners in an agreement, and if it was not covered in the agreement, or the state statute governing the entity, it was “hands off” for judges.

Wyoming Creates An Answer
The answer to this need came from an unlikely place. In 1977, the first LLC Act was enacted in Wyoming. The new statute provided for parties seeking to participate in a business for profit to operate in an entity that brought together both the charging order protection of a partnership, and the limited liability for all interest holders unique to a corporation. In 1988 when the IRS decreed the LLC would be taxed as a partnership, the entity really started to catch on. Many other states started to enact their own LLC Acts. Today the LLC has surpassed the corporation as the most formed entity in the United States.

This picture is from one of STARTright’s training videos that help business owners understand the LLC and how it runs.

Tags: corporations, entity comparison, llc history, partnerships