LLC History, Where they Came From

Limited Liability Companies are fast becoming the go-to business structure for fledgling businesses. This isn’t a surprise considering that a LLC combines the advantages of both a corporation and a partnership, without any of their disadvantages. LLC members get limited liability from the company’s dealings, which mean their personal assets are safe from any loan or debts the company incurs. Only LLC assets can be used to pay the debts or a judgment against the LLC, if the members have not personally guaranteed the debt.

LLCs are also quite easy to set-up and are very flexible when it comes to management and tax concerns. All an entrepreneur needs to do is file a Certificate of Formation (sometimes referred to a Articles of Formation) that contain vital information about the LLC at the local Secretary of State. After that, it’s all a matter of organizing its members and drafting an operating agreement. Either step does not require an attorney to be present but the legal advice of one would never go amiss in any circumstance.

Though it may seem like a new development in the business organization front, the principles of a LLC have been around for more than one hundred years.

LLC History in the European and Latin American Landscape

It was said that the beginnings of the LLC was found in the 1892 German Law. The Gesellschaft mit beschrnkter Haftung drew some inspiration from the English. It patterned some of its rules from the practice of the proved limited company but enough original ideas to merit its own separate creation. Later on, other countries in Europe and Latin America followed suit. Nations such as Portugal, Brazil, France, Chile, Argentina, Turkey, Mexico and Belgium all adapted the GmbH in the span of 45 years. Because Germany was the first civil code country to enact the new legislation, the enactment itself became the focal point for the others who adopted the enterprise. By the latter half of the 1940’s France already made the entity, then referred to as “societes de responsabilite limitee” more prevalent than the conventional corporations at that time. In fact, one-third of all French societies had this structure.

Aside from the limited liability, each country adhered to four basic principles that made the LLC separate from other business structures. First was the required use of the term “limited” in the company’s name. Second, the entity is bestowed with full juristic personality. Third, a member was given the power over the admission of new members. Lastly, the entity was allowed dissolution by the death of a member unless otherwise stipulated in the articles of organization.

Wyoming LLC Follows Suit

It wasn’t until 1977 that the first America state enacted a LLC act based on the GmbH Code. Wyoming became the first state to draft a LLC act permitting the formation of LLCs for any purpose except in the business of banking or insurance. The Wyoming LLC Act also adopted the four basic principles that Europe and Latin America followed. Aside from this, the act added a ruling that barred members or managers from litigation that involved the business. Other LLC acts that succeeded Wyoming’s took this on as well.

Questions arose later on as to whether the LLC would be treated as a partnership or corporation in terms of federal income taxes. In 1988, the IRS finally published a ruling that classified the LLC as a partnership and thus would embody the pass-through status for federal income tax. This would mean that any profit that the business made would be passed through to its members, requiring them to declare these profits or losses in their individual tax returns. Because of this, more and more states began embracing their own Limited Liability Company acts.

Delaware Becomes Leading Authority in LLC

Delaware had its first Limited Liability Company Act in 1991 and had it go through rigorous revisions in 1995 and 1997. Ever since then, it has been amended in smaller terms annually in an effort to maintain Delaware’s act as the leading Act in the US.

Delaware’s Act became so popular that in the absence of an operating agreement or company agreement, the company would be given the Act as its default operating agreement. Presently, it provides much needed substance and guidance to those wishing to form their own LLC. It stipulates that the relationship of the members of the LLC must be governed by a contract.

In the Delaware Act, each member is given the same limited liability as a stockholder of a Delaware corporation. But unlike in a corporation, income, expense and losses of the LLC are recognized by its members for income tax purposes. This means that no income tax must be paid by the entity unless it chooses to be treated as a corporation. There is also no obligation for the LLC to publish a notice of formation or publicly file the names of its members. Neither annual financial reports nor minimum capital requirements are necessary as well.

Presently, the Delaware Act is considered as the mode modern and flexible act in the US with its many provisions and constant process of change.

Right now, LLCs are gaining in popularity because of four main reasons:

  • Limited liability. Members are protected against losses of the company. All they would stand to lose would be their initial investments.
  • Pass-through taxation. Taxes are passed through to the members
  • Management flexibility. Members or owners can be individuals, partnerships or corporations.
  • Profit and loss distribution. It would be up to the LLC members to decide how to divide profits as well as losses among each other. They are not bound to divide profits according to capital contributions.

Its current state allows it to be preferred by most businessmen who are starting out and others who wish to expand on their existing company. Needless to say, the LLC has come a long way from being Germany’s own to a blossoming business structure in America.

About Brian Davis

LLC expert author and advisor. Has advised thousands of entrepreneurs over the last 15 years on which business structure is right for them. Brian is not an attorney or tax professional. If you need tax or legal advice, seek the assistance of a local attorney or CPA.
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