Nicholas P. DiNatale, CPA -
Certified Public Accounting & Business Advisory

Business Resources - FAQ

Limited Liability Company "LLC" (and "LLP") basics…

The LLC and LLP (limited liability partnership) are relatively new organizations that blend some of the flexibility and tax advantages of a partnership, while providing the liability protection of a corporation. Although the rules governing LLCs vary by state, the LLC is afforded some general attributes in all states.

Generally, corporate-type liability protection is provided to each member, limiting their personal exposure to the entity’s debts and liabilities. This is in contrast to the joint and several liability of general and limited partnership entities. This liability protection differs from that offered to limited partnerships in that LLC members can actively participate in the management of the organization, while limited partners may not. LLCs and LLPs differ here, insofar as the protection afforded to LLP members only protects against debts and obligations arising from the malpractice of other members, and generally does not protect against LLP debts and obligations arising during the ordinary course of business.

LLCs are pass-through entities, as such there is no tax at the entity level, much like partnerships and S corporations. It is the members who pay the tax on the results of operations, and not the organization itself. Ordinary income and losses, and certain tax preference items pass-through to the individual income tax returns of LLC members where the amounts are included as part of adjusted gross income. LLC ordinary income is generally subject to self-employment tax as well as income tax.

Since LLC members are not employees of the entity they are not paid as part of the regular "payroll." Compensation paid to members amount to "draws" or "guaranteed payments" which are subject to self- employment and income taxes. The LLC has the ability to allocate these distributions on a basis specific to each member in accordance with the operating agreement, (an opportunity not afforded to S-corporation shareholders). Since income and social security taxes are generally not withheld from these payments an effective tax plan is key for LLC members, as they will have to make estimated tax payments to cover any anticipated tax balances due.

Other benefits over the traditional S-corporation include no limits on type or number of members, or capital structure. Additionally, the LLC can distribute property to members without gain, and members can contribute appreciated property for membership interest, also without recognizing gain. These attributes enable the LLC to prove its value by serving in a variety of roles and uses where a corporation or partnership may provide significant deficiencies.

The LLC seems like the ideal choice of entity, but there are some significant disadvantages. Because a LLC is basically a partnership, most states require the organization to be comprised of 2 members. While local regulations may allow single member LLCs, federal regulations require single members to file their federal tax returns as sole-proprietorships. Also, to be considered is the effect of the varying state laws on the LLC when interstate commerce is an issue. Because each state views the LLC entity differently, entities doing business in multiple states should be aware of whether their LLC qualifies in the other jurisdictions, and how their income will be taxed by each authority.

Today’s most attractive employee benefit for emerging businesses is stock options. Because the LLC is not a corporation, it cannot issue stock options, or take advantage of other stock-based preferences. Since many companies, especially techs with an IPO in their future will be better served as a C-corporation, long-term goals should be considered when making the choice of entity.

Is an LLC right for your business? Your choice of entity is should be dictated by the type of business you are running, long-term strategy, and capitalization. The LLC/LLP is one of a number of entity types which should be considered. Consult your tax advisor for additional information.

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