About Limited Liability Companies
The Massachusetts Limited Liability Company ("LLC")
The Massachusetts limited liability company is a form of business organization in Massachusetts. The statutory authority is the Massachusetts Limited Liability Act (the "Act"), which became effective on January 1, 1996.
The Massachusetts Limited Liability Company (the "LLC") is an unincorporated form of business organization similar to a partnership, but possessing a limited liability "shield" which protects its owners from liability to the same extent that stockholders of a corporation are insulated from its debts and obligations. A properly structured LLC will be treated as a partnership for federal and Massachusetts income tax purposes.
Under the Act, an LLC is formed when its certificate of organization is accepted for filing by the Secretary of State of the Commonwealth. Those who hold an equity interest in the LLC are referred to as "members". Currently, the Act requires a minimum of one (1) member to form the LLC.
The certificate of organization must be filed in duplicate with the filing fee of $500. Every LLC also must file an annual report with the Secretary of State on or before the anniversary date of the filing of the certificate of organization. The annual report essentially updates the information contained in the original certificate. The filing fee for the annual report is $500.
The attractiveness of the LLC derives from its principal attributes: a single level of income tax and limited liability for the owners/investors. A properly organized LLC is classified as a partnership for tax purposes and not taxed at the entity level. Its members face only one level of income tax. Items of income, gain, loss, deduction, and credit flow through to the members. The LLC provides members with broad limits on liability. Participation in the management of the LLC does not subject a member to general liability.
The determination of whether an unincorporated entity, such as an LLC, will be categorized for income tax purposes as a partnership, rather than as a corporation, turns on whether the entity lacks at least two of the following four "corporate" characteristics:
- limited liability;
- continuity of life;
- centralized management; and
- free transferability of interests.
Because the Massachusetts statute allows members to tailor the structure of the organization to their needs, avoiding characterization as a corporation requires careful planning.
As its name implies, an LLC generally possesses the "corporate" characteristic of limited liability. An LLC's essential purpose is to offer both limited liability and partnership tax treatment to its owners. Because Massachusetts limited liability companies will always possess the corporate character of limited liability, close attention must be paid to the three remaining corporate characteristics.
If the LLC possesses more than one of the other characteristics, it will not be treated as a partnership for income tax purposes. In that event, all of the LLC's income will be taxable twice - once when the LLC earns the income, and a second time when the LLC makes distributions to its members.
The Massachusetts LLC statute is known as a "flexible" LLC law. The statute allows variations with respect to the remaining corporate characteristics, tailored to the needs and concerns of the owners. Thus, whether the particular LLC will be classified as a corporation or partnership depends on the terms of the specific operating agreement. That agreement is analogous to a partnership agreement or to the articles of organization of a corporation.
Generally, the operating agreement omits the following "corporate characteristics":
- Continuity of Life - The LLC lacks continuity of life if upon a dissolution event (i.e., death, insanity, bankruptcy, retirement, resignation, expulsion) of any member, the LLC is dissolved unless a majority in interest of the remaining members vote to continue the LLC.
The Company lacks the corporate characteristic of continuity of life, because an event such as the death, retirement or bankruptcy of a member will automatically cause the dissolution of the entity. The business of the Company may thereafter be continued only with the consent of all of the remaining members. However, as previously noted, current law requires a minimum of two members for formation and continuity of an LLC.
- Centralization of Management - The LLC lacks centralized management. The Internal Revenue Service has ruled that an LLC lacks centralized management if the LLC is managed by the members exclusively in their membership capacity (e.g., where the LLC is managed by all the members).
The Company lacks the corporate characteristic of centralized management, because it is managed by all the members and any member's actions can bind the entity.
Provision may be made in the Operating Agreement to allow for the appointment of a "manager" to carry on the day-to-day affairs of the Company. The members have sole discretion to appoint or remove the manager. That manager's authority is ministerial only. The manager may only make decisions on behalf of the Company which are within the ordinary course of its business.
Due to the complexity of the Operating Agreement, the tax implications involved in structuring the economic, business and management arrangements of the Company and its members, and the need to anticipate issues and provide mechanisms for their timely and effective resolution, I recommend that these documents also be reviewed by an accountant who is familiar with the IRS rules and regulations governing LLCs.
It is important that a Massachusetts LLC transacting business outside of the Commonwealth exercise due care in its dealings in any other jurisdiction. All states have adopted LLC statutes; however, the requirements vary from state to state. Among other considerations, a domestic LLC must be sensitive to licensing and taxation issues in other states. For example, "foreign" LLCs doing business in Connecticut must register with the Connecticut Secretary of State before doing business in that state. Annual reports must be filed. The initial registration fee is $60; the fee for filing the annual report is $10. The financial penalties for noncompliance are severe.