A LIMITED LIABILITY COMPANY (“LLC”) is not a “limited liability corporation.” They are two separate, legal structures that may be utilized to engage in a variety of business ventures and enterprises. A business corporation (“corporation”) is a business entity that exists separate from its owner(s) (i.e. shareholder(s) a.k.a. stockholder(s)) and is centrally managed by a board of directors. An LLC is also an entity that exists separate from its owners (i.e., members), but, in its simplest form, is managed by its owners, not by a managing board. The following identifies other key differences between LLCs and corporations.
Corporations have been available in all states for many decades. LLCs have been available in New Jersey since 1994. By comparison, LLCs are relative newcomers. When LLCs first appeared on the scene, many people were confused as to their exact nature. Even in the legal community, there was debate as to whether LLCs should be treated like partnerships or corporations. Although LLCs have attributes of both partnerships and corporations, they are neither. The confusion and debate has subsided in recent years because of the growing popularity of LLCs.
A corporation or LLC cannot exist until a creation document is filed with the appropriate state office. In New Jersey, the document which creates a corporation is called a “Certificate of Incorporation” and the document which creates an LLC is called a “Certificate of Formation.”
After creation, both corporations and LLCs must register with the state for tax and labor purposes. In addition, both corporations and LLCs must file annual reports and pay the related filing fees to maintain their existence. Corporations have additional post-creation formalities, including holding an organizational meeting of the directors to issue stock, adopt bylaws, elect officers and conduct other organizational business. Corporations must also hold annual shareholder meetings. LLCs are not required to formally organize after creation or have directors, officers, bylaws or annual member meetings.
Both corporations and LLCs afford a liability shield. That is, shareholders and members are not personally liable for debts and obligations incurred in the normal course of business. However, there are numerous exceptions to the general liability shield rule. Appropriate steps should be taken to manage risk (e.g., insurance) and maintain the liability shield (e.g., proper entity formation, business practices, and observance of organizational and operational formalities).
As a general rule, LLCs report income, but do not pay federal income tax. Income and losses flow through to members who then determine individual tax obligations. Corporations must pay taxes on income and, if profits are distributed to shareholders via dividends, the dividends are taxable to the shareholders. Small, qualifying corporations can avoid this “double taxation” by electing Subchapter S corporation status.
Transfer of Ownership
The ownership interest in a corporation (i.e. stock) is freely transferable. By comparison, a member of an LLC may freely transfer his or her right to receive profits, but the right to participate in management is not, as a general rule, transferable. In most cases, the membership interests in an LLC and stock in privately owned corporations are not readily marketable. That is to say that there is no “exchange” where such ownership is traded in a public manner.
It is prudent for owners of LLCs and corporations to have written agreements that address preserving and controlling the entity’s ownership and management, assuring marketability of ownership interests, and resolving potential decision-making “deadlocks.” Most typically, owners of a private corporation utilize a Shareholder Agreement. In LLCs, the document that serves a similar function is referred to as an Operating Agreement.
This article is provided solely for the general interest of the reader. The article and its contents are neither intended as, nor should be construed as, legal advice or opinion. Legal advice and opinion are provided by the firm only upon engagement with respect to specific factual situations.
Barry F. Gartenberg, L.L.C.
Attorney at Law
505 Morris Avenue, 1st Floor
Springfield, New Jersey 07081