Thursday, April 1, 1999
A Limited Liability Company, (LLC for short) was established as a new form of doing business to combine the characteristics of both a corporation and a partnership. Contrary to popular belief, a Limited Liability Company is not a corporation. Like a corporation, it is treated as a separate entity under state law and provides liability protection for all of its owners, but has none of the formalities or red tape associated with corporations.
The owners are called “members” and can be individuals or entities, such as corporations, other LLCs, trusts, pensions, etc. An LLC is established by filing a form, usually called Articles of Organization, with the Secretary of State. Most states require that an annual report be filed to keep them apprised of the current status of the entity. Some states also require that the LLC have an operating agreement of some kind. An operating agreement is a written agreement between the members as to how the LLC will be managed and can contain various provisions that provide tax benefits to the owners.
Advantages
The Limited Liability Company enables a business owner to have the legal shield provided by corporations with none of the corporate formalities or red tape. Once in place, it does not need ongoing high maintenance and can be easily modified as circumstances change.
Like a corporation, an LLC protects your personal assets from business creditors; it also protects your business assets from your personal creditors. Unlike a corporation, your personal creditors cannot receive an ownership interest in your Limited Liability Company.
In most states, a charging order is the only remedy available to a personal creditor. When a charging order is issued, a creditor can only receive distributions that you receive as a member of the Limited Liability Company. As you might imagine, distributions from the Limited Liability Company will be few and far between when a creditor is looking over your shoulder, ready to collect any distributions given to you. You can, however, still receive advances, enter into joint ventures, receive loans or receive funds from the Limited Liability Company by any other method that is not classified as a distribution or salary.
A Limited Liability Company can be taxed as a partnership or as a sole proprietorship (provided your state allows one-member LLCs). If you structure your Limited Liability Company to be taxed as a sole proprietorship or a partnership, profits and losses will be reported on the owners’ tax returns, thus eliminating the double tax on corporate profits. If you dissolve it, unlike a corporation, there are no capital gains taxes on the assets that you receive as a result of the dissolution.
If there are tax reasons for forming a corporation, an LLC can elect to be treated as a corporation for income tax purposes and still retain all of the flexibility and asset protection benefits provided under state law.
What Are the Disadvantages of an LLC vs. a Corporation?
The only disadvantage to operating as an LLC vs. a corporation is that if you have your LLC taxed as either a sole proprietorship or as a partnership, you must pay a self-employment tax on all business profits. With a corporation you pay a self-employment tax only on the amount that you are paid as a salary.
When self-employment taxes are an issue, two LLCs can be used: a management LLC and an operating LLC. This enables you to control the level of self-employment taxes paid and provides a much higher level of creditor protection. Also, the IRS is currently examining its position and is expected to issue regulations that will allow an LLC to separate the owner’s salary from the remaining profits for purposes of the self-employment tax.
Strategies for Using a Limited Liability Company
If you are currently operating your business as a sole proprietorship, consider converting to an LLC. There are no negative tax implications, as the IRS ignores the LLC for tax purposes. By converting to an LLC, an owner of a sole proprietorship can prevent business creditors from using personal assets to satisfy business debts. You also prevent personal creditors from acquiring an interest in your business to satisfy personal debts. If your state does not allow a one-person LLC, than you can use a spouse or family member as an additional partner by giving them a very small interest, such as 1 percent.
Corporations present unique problems and opportunities. If your corporation has substantial assets that can be attacked by business creditors, discuss stripping those assets out into an LLC. Your corporation can then lease those assets back; yet if a creditor were to attack your operating business, the high-value assets transferred to your LLC would be protected. This is just one way that the owners of a corporation can benefit by using one or more LLCs in conjunction with their corporation.
Whether you are just starting a new business or have been in business for a number of years, you should provide yourself with as much protection as the law provides. Not to do so makes no sense. A Limited Liability Company provides you with the ability to engage in business without the fear that one mistake could wipe out your personal assets and without the red tape associated with a corporation. It is truly the entity of choice for business owners.
