Limit Liability and Cut Taxes With An LLC

Posted on Tuesday, January 03, 2017

There is generally no one legal structure that works best for all businesses. The most favorable choice depends on a number of factors, including the number of owners, your tax situation and whether or not you have employees. A limited liability company (LLC) may be a good choice because it provides flexibility, low maintenance, favorable tax treatment and most importantly, limited liability protection to keep your personal assets safe.

Alternative Types of Business Entities

Sole Proprietorships don't face organizational formalities and reporting to governments. However, the owner has unlimited liability for the obligations and debts of the business.

General Partnerships are sometimes used when there is more than one owner. They also involve the partners having unlimited liability for the obligations of the business.

Limited Partnerships are sometimes used in businesses involved in real estate and the motion picture industry. The general partners have unlimited liability, but the limited partners are only at risk for their investment in the partnership.

C Corporations must file a Certificate of Incorporation with the state. Shareholders have limited liability.

S Corporations are limited to 100 shareholders, which must be individuals, estates or certain types of trusts. Shareholders have limited liability.

A properly-organized LLC combines some of the aspects of partnerships and corporations into one entity. For example, general partnerships and sole proprietorships generally have no insulation from liability. But by statute, a member of an LLC has limited liability and no personal responsibility for the debts or liabilities of the entity or the other members.

LLCs can work well for family businesses that have exposure to product or other liabilities, real estate enterprises and service companies.

Discuss the specific benefits of various business structures with your attorney and accountant, keeping in mind that the laws regulating LLCs vary from state to state. Here is a list of general LLC issues to consider:

Tax Treatment

Federal and State. Limited liability companies with more than one member (owner) can avoid double taxation because they can be treated as partnerships for tax purposes. An LLC with a single individual member (owner) can be treated as a sole proprietorship for tax purposes.

In such cases, the LLC is a tax "pass-through" structure. It files a federal tax return, but passes through all of its tax profits or losses to its member or members, who then pay tax on their personal returns. Under a C corporation structure, your company pays taxes on its earnings and then you pay again if the company's post-tax earnings are distributed to you as taxable dividends.

Employment. LLCs, like S corps and partnerships, distribute income to their members and the money isn't considered wages by the IRS so there are no employment taxes. However, members may owe self-employment tax. Of course, an LLC must pay employment taxes for its employees.

The Basics of Setting Up

Formation. It's fairly easy to form an LLC: You file an Articles of Organization form with the state and pay a fee. You also create an operating agreement among the members. This document establishes members' rights, the percentage of ownership and the share of profits. You generally have to publish a notice in a newspaper a certain number of times, which may be expensive depending on your location.

Owners can include corporations, partnerships, other LLCs or trusts. An operating agreement should also contain provisions for the company's management structure and any other financial details you want, such as ways to use the LLC in estate planning.

Qualification is required for doing business in other states. Regular reporting to governments is required. Interests are not freely transferable.

Management. In nearly every state, you can form an LLC with just one person but there's no limit on the number of members you can have. In theory, all members can participate in managing the company. But smooth operations normally depend on a centralized management to ensure good communication and the ability to reach consensus. In your operating agreement, you can designate one or more owners (or even an outsider) to take on daily management responsibilities.

Liability and Succession

Limited liability. LLC members aren't personally liable for the company's debts or obligations. However, this is not blanket protection. Members may still be liable for debts if they personally guarantee them. And they're liable for their own professional malpractice, if they personally injure someone, don't deposit taxes withheld from employees' wages or use the company to conduct personal business. Beyond that, members are liable only up to the amount of their capital contributions and the amount they agree to contribute to the firm's capital.

Continuity. Interests are not freely transferable and a transfer may be subject to securities law regulations. Depending on state law, an LLC could go out of business upon the death, disability, bankruptcy, retirement, resignation or expulsion of a member. The remaining members would have to wind up business and distribute assets among themselves. You can avoid this by including in your operating agreement a "buy-sell" provision to provide guidelines in the event a member is no longer involved.

An LLC's tax advantages, combined with corporate-style insulation from liability, can make it a suitable and cost-effective alternative to other business models. Consult with your tax advisor about the best business entity in your situation.

Posted in Tax And Accounting Topics For Business

Disclaimer: The information contained in Dulin, Ward & DeWald’s blog is provided for general educational purposes only and should not be construed as financial or legal advice on any subject matter. Before taking any action based on this information, we strongly encourage you to consult competent legal, accounting or other professional advice about your specific situation. Questions on blog posts may be submitted to your DWD representative.

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