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LLC

Description

L.L.C.’s have become an especially popular form of business ownership in recent years, although they first became available in 1977.

An L.L.C. blends some of the features of partnerships and corporations. Perhaps most important, members of an L.L.C. enjoy limited liability, much like shareholders of a C-Corp., but they are not subject to the double-taxation problem faced by corporations. Specifically, the L.L.C. does not pay federal or state income taxes directly but passes gains and losses on to the L.L.C. owners in proportion to their ownership. The gains or losses are then reported on the owners’ individual personal income tax returns, as in partnerships.

Beyond this, there is no limit to the number of shareholders L.L.C.’s may engage. Having said this, L.L.C.’s do not actually issue shares, but instead deal with owners in terms of their investment in the small business.

For example, Romeo and Juliet formed an L.L.C. in which Romeo contributed $200,000 and Juliet, $300,000. The R&J L.L.C. earns $100,000 before taxes. Thus, Romeo earns 40 percent of this (40% x $100,000 = $40,000), and Juliet earns $60,000.

Regarding management, L.L.C. owners may participate fully in managing the small business’s operations. Unlike limited partners, they face no restrictions.

To set up an L.L.C., the prospective owners establish the entity at the state level by filing articles of organization, entering into an operating agreement that defines their rights and obligations as members (much like a C-Corp. shareholders’ agreement). L.L.C.’s do not have a perpetual life, so small business owners must check state laws to learn about limits to the lives of their L.L.C. small businesses, and then plan accordingly.

Tax Treatment

The IRS considers “L.L.C.” a state designation and therefore requires taxpayers to file under one of the business ownership forms that it recognizes. The small business L.L.C. will always file at the state level as an L.L.C., but in some cases it will file at the federal level as one of the following:

Sole Proprietorship. The single L.L.C. owner files a Schedule C with a Form 1040.

Partnership. As in a general or limited partnership, the L.L.C. files Form 1065 (Return of Partnership Income); gives K-1’s to the investors in proportion to their ownership; and requires that owners enter the K-1 information on their individual income tax returns.

Subchapter S Corp. The Sub S files Form 1120S (basically a corporate tax return), and investors carry this amount onto their personal tax returns via Schedule E, which carries onto individual tax returns. To file as a Sub S with the IRS, the firm must register as a Sub S as described previously.

Corporation. The corporation files Form 1120S and pays the taxes. Individual investors pay taxes only upon receiving gains and dividends. Note that in this case, the L.L.C. may not avoid the problem of double taxation.

Although the L.L.C. is increasingly popular among small businesses, the laws are still new and untested. Accordingly, there is still great uncertainty as to how well the “limited liability” benefit of an L.L.C. will really stand up when attacked by creditors. We can only wait and see how this develops in different states and over time.

Additional protection may be gained by organizing the ownership through an offshore managing company to provide asset protection.

Due to the uncertainties involved in organizing and operating an L.L.C., an experienced attorney or CPA should assist in the structuring if issues such as asset protection and corporate tax treatment are complex.