The Birth of the Limited Liability Company (LLC) - dummies

The Birth of the Limited Liability Company (LLC)

By Jennifer Reuting

The limited liability company (LLC) didn’t come out of nowhere. Business entities with the same characteristics as LLCs have been around for many years. The origin of LLCs can be traced back to the Germans. In 1892, German law enacted what was called the Gesellschaft mit beschränkter Haftung (GmbH) — a modern-day variation of the English private limited company.

After Germany established the GmbH, the concept soon spread throughout Europe and Central and South America. By the 1940s, in France especially, the concept of the limited liability company was becoming more popular than the traditional corporation.

Not that Germany can take all of the credit. In 1874, Pennsylvania authorized the use of a Limited Partnership Association. By 1875, Michigan, New Jersey, Ohio, and Virginia had enacted similar legislation after seeing how the entity type was gaining popularity in Pennsylvania. Unfortunately, the laws of the time required that the company headquarters remain in one of those five states. Because those states weren’t huge epicenters of American commerce, the new legislation began to lose popularity.

In 1977, Wyoming decided to spearhead an effort to build upon the antiquated Limited Partnership Association and enacted the first true LLC act. The legislature modeled the act after the German GmbH and the successful Panama version of the LLC. Because of Wyoming, the modern-day LLC protects all partners from the liability of the business and has a double layer of liability protection that protects the business from your personal creditors.

After Wyoming, Florida followed suit in 1982. However, LLCs weren’t popular entities. Because they were hybrid entities — between a corporation and a partnership — the IRS had yet to decide how it was going to tax the LLC. After all, would you really want to form a business entity without knowing what sort of tax structure would be imposed on you?

Finally, in 1988, the IRS ruling came: LLCs would be taxed as partnerships. The business’s profits and losses would flow through to the owners, and the LLC wouldn’t be recognized as a separate entity for tax purposes. After this ruling occurred, states began to form their own versions of LLC law.

After a while, the public became more familiar with LLCs and began to form more of them. As they were more commonly used, case law built up, which gave members a more solid idea of what the LLC’s legal limitations are.