| Should you operate your business as a corporation? | | | | $2,000. This can be very attractive in a partnership in |
| Or is there another, simpler alternative? | | | | which there is a significant difference in the amount of |
| You've probably noticed that in the past decade there | | | | capital and ongoing business activity that the partners |
| are more and more businesses with their names | | | | are contributing to the business. |
| followed by the letters "LLC" instead of "Inc.". "LLC" | | | | 3. The LLC is not subject to the same corporate |
| stands for Limited Liability Company, is the newest | | | | formalities that are required of the S or C corporation. |
| type of legal entity that exists in the United States, and | | | | While the LLC must still maintain appropriate LLC |
| for many entrepreneurs it is the ideal marriage | | | | records and bookkeeping, it is not required to be |
| between the tax advantages of the limited partnership | | | | managed by a board of directors and maintain minutes |
| and the limited liability feature of the corporation. Now | | | | of regular board of directors meetings. |
| available in all 50 states---even to non-U.S. | | | | 4. Unlike the S-corporation, liquidation of an LLC is |
| citizens--most likely the LLC should have a key place in | | | | generally not a taxable event. As your personal and |
| your business structure. | | | | business financial situation change over time, you may |
| When it comes to legal entities for conducting business, | | | | determine that it is no longer in your interest to maintain |
| limited liability companies are the newest kid on the | | | | a "pass through" entity for your business. Once your |
| block in the United States. The state of Wyoming was | | | | business begins to turn a regular profit after the |
| the first to pass legislation, in 1977, to establish this new | | | | relatively high costs of the first year or two, you may |
| entity. By 1999 all fifty states in the United States had | | | | decide that a C-corporation that is taxed at a |
| enacted legislation to allow the formation of this | | | | maximum of 25% (unless it is a personal service |
| exciting new legal entity. | | | | corporation) would be more advantageous to you. If |
| But why is the LLC so attractive, so irresistible to | | | | you have been operating as an S-corporation and you |
| legislators? And why have so many entrepreneurs | | | | liquidate it by selling the liquidated assets to the |
| opted for the LLC instead of a "C" corporation, or | | | | shareholder(s) at their fair market value, the liquidation |
| even an "S" corporation? And most important, how do | | | | will be a taxable event. This does not apply to the LLC. |
| you decide if it's right for you? | | | | This is one of the factors that makes the LLC |
| Perhaps the most important reason is for the | | | | particularly attractive for holding real estate. |
| popularity of the LLC that the it satisfies the demands | | | | 5. The concept of the charging order makes the LLC |
| of both accountants and attorneys. Accountants tend | | | | especially effective for asset protection. This makes it |
| to prefer the Limited Partnership ("LP") because they | | | | a particularly attractive entity for holding real estate. |
| are concerned about the dangers of "double taxation" | | | | The corporation should not be used to hold real estate, |
| if their clients use a corporation: If your corporation | | | | because if the corporation is sued, the court might |
| pays dividends, the corporation pays taxes on its | | | | award shares in the corporation in the judgment. |
| profits, and its shareholders pay taxes again on those | | | | Control of the corporation translates into control of the |
| same profits when they are taxed on the dividends | | | | property, and you effectively lose control over your |
| they receive. By contrast, attorneys usually prefer the | | | | real estate holdings. |
| greater asset protection offered by the limited liability | | | | By contrast, the charging order, used with Limited |
| that the corporation has to offer to all its owners. | | | | Liability Companies as with Limited Partnerships, gives |
| Let's begin with an understanding of what the limited | | | | the plaintiff only the right to receive income distributions |
| liability company is. Basically it is a partnership among | | | | from the interest of the party or parties against whom |
| its owners, who are called "members". The LLC is like | | | | the suit was brought. The charging order grants no |
| a limited partnership (and an S-corporation), because it | | | | voting rights or management powers. Thus, the |
| is a "pass-through entity"--each partner's or member's | | | | existing managers or members could vote simply not |
| share of the net gain or loss for the year "passes | | | | to distribute income, thus leaving the plaintiff with no |
| through" to the individual tax-payer's 1040 individual tax | | | | recourse; yet the plaintiff will have to pay taxes on the |
| return. There is no separate tax to which the LLC itself | | | | income allocated to her, even though the funds were |
| is subject. On the other hand, the LLC is also like a | | | | not distributed(!). This offers a strong incentive for the |
| corporation, because unlike the limited | | | | plaintiff to negotiate for a settlement. |
| partnership--which requires a general partner, who is | | | | Clearly, the LLC is a powerful tool for protecting your |
| responsible for all results of all decisions and actions of | | | | assets against financial predators. If you use it for real |
| the partners--all its owners benefit from limited liability. | | | | estate holdings, you can maximize this protection by |
| People choose to form LLCs basically for the same | | | | holding each piece of real estate in a separate LLC. |
| reasons that they would elect to set up an | | | | Thus, if one LLC comes under attack from financial |
| S-corporation or a limited partnership. The LLC, like the | | | | predators, the operations affecting only a single |
| S-corporation, is attractive if you have earned income | | | | property will be affected. |
| that puts you in a high tax bracket, and you would like | | | | Disadvantages of the Limited Liability Company |
| to be able to offset that income with the losses that | | | | Needless to say, there are some disadvantages with |
| you can normally expect to incur in your first years in a | | | | the LLC--otherwise there would not be remain so |
| business. When I formed my first business entity | | | | many other attractive options for structuring your |
| twenty years ago, my husband and I selected the | | | | business. Why might the LLC not be the best option |
| S-corporation. We both had salary income that placed | | | | for you? |
| us in a high tax bracket, and we knew that our new | | | | 1. Increased taxes for LLC members in high tax |
| consulting business would incur significant capital | | | | brackets. Once your LLC is making a profit, its income |
| expenses in the first few years. After all, we would | | | | passes through the individual members, who are taxed |
| have to purchase new equipment such as a fax | | | | directly on that income, whether it is actually taken out |
| machine, a laser printer, personal computers, and the | | | | of the LLC or not. Thus, members who are in a high |
| replaceable supplies to operate them. We were also | | | | tax bracket might pay higher taxes than they would if |
| aware that it would take some time to build a clientele, | | | | they used a C-corporation, which is subject to lower |
| so our income from the business would take a few | | | | marginal tax rates. Proper planning of disbursements |
| years to take off. The S-corporation allowed us to | | | | for expenses and other aspects of the business could |
| carry the losses we incurred onto our individual 1040 | | | | overcome this disadvantage. |
| tax returns. The losses were deducted from our gross | | | | 2. Higher initial filing fees for LLCs in some states. |
| personal salary income, and we paid dramatically lower | | | | Some states may levy heavier tax obligations on |
| taxes. | | | | LLCs in their initial years. Our home state of California |
| If you can get this advantage from an S-corporation, | | | | requires that an LLC pay a minimum $800 tax in its |
| why would you bother with an LLC? The LLC has a | | | | first year, while corporations are exempt in their first |
| number of advantages over the S-corporation: | | | | year--whether the business has any earnings or not! It |
| 1. First, LLC does not have the limitations that the | | | | can still be worthwhile for you to start an LLC: If you |
| S-corporation has on who can be a member of the | | | | have high start up costs, tax savings in the thousands |
| LLC. Only individuals, estates, some trusts, and other | | | | of dollars will outweigh these higher filing fees. |
| S-corporations can be members of an S-corporation. | | | | 3. Unlike corporations, LLCs do not have continuity of |
| Individuals (shareholders) must be either U.S. citizens or | | | | life, that is they are limited usually to a specific period |
| residents. By contrast, the LLC is not subject to these | | | | of time (say, 50 years) depending on the state. If an |
| limitations. Thus, it is an ideal entity that you can | | | | LLC member dies, the remaining members may vote |
| combine with other entities in your business structure. | | | | to continue the LLC business. LLC interests can be |
| For example, you can have a corporation or other | | | | gifted to other family members; and the LLC can have |
| legal entity be a member of an LLC. | | | | a trust or family limited partnership as a member, thus |
| 2. The LLC has much greater flexibility for allocation of | | | | providing for effective estate planning. |
| rights, profits, and assets than the S-corporation. The | | | | 4. The LLC is a relatively untested entity. There is the |
| S-corporation can have only one class of stock: In | | | | large body of case law on corporations but on LLCs. |
| other words each share of stock has the same rights | | | | We may also expect to see changes in the laws |
| as every other share. This means that the allocation of | | | | governing LLCs as the implications of this new entity |
| profits and assets is extremely rigid. If Parties A and B | | | | become more apparent to legislators. |
| are equal shareholders in a corporation, and the | | | | Space does not permit coverage of all the |
| corporation decides to distribute its profits of $10,000, | | | | advantages and disadvantages of LLCs, but clearly |
| then A and B must each receive $5,000. This might | | | | the LLC can be a powerful tool for operating your |
| not necessarily be equitable if one partner was much | | | | business, protecting your assets, and planning your |
| more active and produced a much greater share of | | | | estate. It is easy and inexpensive to set up on your |
| the profits than the other. The LLC allows for A to | | | | own, if you use one or more of the items on our |
| receive, say, $8,000 if its business activities generated | | | | Wealth Structuring Resources page. |
| 80% of the profit, leaving B with the remaining 20%, or | | | | |