The limited liability company in seven easy lessons: a tax executive's primer.

• Author: Elwood, William E.

OK, so you're the Tax Director of a publicly held C corporation or you're the financial and tax guru at a growing S Corporation. No need for you to know about limited liability companies, right? Wrong! If it hasn't happened yet, you will soon bump into the hottest new business structure in decades, and the Tax Department needs to be ready.

Lesson 1: What is an LLC?

Conventionally, in the United States, large businesses with significant capital needs have been established as C Corporations. Tax executives are usually aware that organizers of smaller businesses or discreet projects might use a partnership structure, but the tax adviser's role did not usually extend to determining whether a flow-through structure would produce tax savings.

For many years, the only significant variations in this simple C Corporation/partnership dichotomy arose in respect of small businesses. They were the possibilities that a smaller corporation's shareholders might elect to be taxed under Subchapter S of the Internal Revenue Code or that a partnership might be established as a limited partnership. Of course, both the Subchapter S corporation and limited partnership variations were efforts to obtain insulation from business liabilities while mitigating the socalled double tax that results when a C corporation pays federal income taxes on its profits and the shareholders pay federal income taxes a second time when those profits are distributed to them as dividends.

Enter the LLC--a legal entity with big business application that offers an exciting alternative to use of either a corporation or partnership.

The LLC is often described as a hybrid entity, something between a corporation and a partnership. This seems to be largely based on a properly organized LLC's combining the most desired business attribute of a corporation, statutory insulation against liability for all investors, with the most desired business attribute of a partnership--elimination of the double tax on business earnings. Although the LLCs combination of limited liability and tax savings is in some ways similar to the benefits afforded by a Subchapter S corporation or a limited partnership, the LLC is in many respects a very distinct and more flexible structure rather than the simple mixing of corporate benefits with partnership tax treatment.

Lesson 2: LLC Speak--A New Vocabulary

Key distinctions between the LLC and both corporations and partnerships are underscored by the LLC's unique nomenclature, reflecting its distinct organizational and documentary structure. First, the entity itself is referred to as a company when the full term "limited liability company" or the abbreviation "LLC" is not used. LLCs, like corporations and partnerships, are created by a filing with the State. But an LLC files neither corporate Articles of Incorporation nor a partnership Certificate of Partnership. Instead, it files Articles of Organization. Like the corporate and partnership counterpart documents, the LLC's Articles of Organization set forth the information needed to be in the public domain including the name and address of the company's registered office and agent.

The owners or investors in the company are members rather than shareholders or partners and, like a partnership and unlike a sole shareholder corporation in most States, there must be at least two members. The agreements and understamembers themselves with respect to operation of the LLC are reflected in an Operating Agreement. This may have some elements of a corporate shareholders agreement and bears a strong resemblance to a partnership's partnership agreement. Like partners in a general partnership and unlike shareholders, the LLC's members have the right to participate in management of the company and its business activities. Such participation, however, is not compulsory and some or all of the members may vote in a shareholder-like fashion to delegate supervision of the LLC's activities to managers. Managers' authority is...