As a business, or individual looking to conduct business, one may be faced with the challenge of deciding what will be the most useful, profitable, and practical instrumentality to conduct such business. Historically, entrepreneurs had a few choices in business entities, none of which offered much versatility in comparison to the modern Limited Liability Company. These earlier, more unpopular, business classifications include, Limited Liability Partnerships, Limited Partnerships, and Limited Liability Limited Partnerships, all of which offered lucrative, yet sometimes complex, benefits. In today’s businesses the relatively new Limited Liability Company, or LLC, has proven to be one of the most favorable business entities for its preferential tax treatment and the liability shield it provides to its members.
Traditionally, entrepreneurs who sought to minimize taxes usually conducted business as a sole practitioner or as a partnership which enabled the person or persons conducting the business to be taxed individually. Consequently, however, such business forms left the owners subject to personal liability for the debts and obligations of the business. Such individual liability had its obvious downfalls, as the owner of the business could lose everything, including non-business related assets, if the business could not pay its debts or lost a lawsuit. Conversely, entrepreneurs could incorporate his or her business, which has the legal effect of establishing a completely new and separate entity. It was this entity, the corporation, that would be solely liable for the debts and liabilities incurred in the course of business-essentially shielding its individual shareholders from personal liability. As a downfall however, corporations are taxed much differently than sole proprietorships and partnerships and are in fact taxed twice (once as a corporation and once as shareholders of the corporation). This double taxation, especially for dividend issuing corporations, was not the best avenue for businesses looking to minimize its annual tax liability.
To remedy this ongoing need, the Limited Liability Company was born. The LLC is often referred to as a hybrid, taking the benefits of a corporation and a partnership, and becoming its own business entity. Tennessee in 2006, revised its current law addressing LLCs and adopted the Tennessee Revised Limited Liability Company Act, § 48-249-101, which now provides entrepreneurs with an instrumentality that enjoys the limited liability and preferential tax treatment. § 48-249-114 of the Act provides that the members of the LLC are not to be held personally liable for the debts or torts of the LLC, but that the LLC is solely liable. Further § 48-249-1003 of the Act allows any LLC to be classified as a partnership for tax treatment-taxed once, which differs than typical corporation taxation. While an LLC seems to receive the best of both worlds in regards to taxation and member liability, it is otherwise treated much similar to a corporation in that its members owe the same fiduciary duties (duty of loyalty and duty of care) to the LLC as they would as shareholders of a corporation.
Creation of an LLC is relatively simple, one must prepare and file the LLC’s Article’s of Organization with the Tennessee Secretary of State’s office. Once the LLC is validly formed, it is free to conduct business in accordance with its operating agreement, or if none is present, to the extent allowed by state and federal law. Even when the LLC has been validly formed, its members must maintain and recognize certain corporate formalities to ensure the LLC does not lose its limited liability status. These formalities include having annual member meetings, recording minutes, etc. which illustrate that the LLC is not just a conduit for individuals to use as a protection from personal liability. Even with these annual requirements, forming or converting to an LLC, as well as maintaining the LLC, is a relatively simple process that offers entrepreneurs the “best of both worlds” insofar as providing preferential federal, state, and local tax classification, while simultaneously shielding its members from personal liability.