Reasons & Features to Forming an LLC

January 28th, 2016 at 11:33 AM

One of the most common business entity types that is formed today is the limited liability company (LLC). I have many clients that are unsure as to why to form this type of entity and where. Compared to a corporation or sole proprietorship, and LLC is still a relatively new form of doing business. Its important to understand the benefits, features, uses, and limitations of the LLC.

LLC Features and Limitations

1. Taxes–The LLC is allowed to file its Federal Tax Return as an S Corporation, C Corporation, Partnership, or Sole Proprietorship. To file as an S or C Corporation special elections must be made with the IRS within specific time frames. Whichever type of entity the LLC reports its income, the tax deductions remain the same–there is no advantage as an S or C corporation, for example.
2. Limit Personal Liability for Members–For liability purposes, the LLC serves to protect the members from being personally liable for debts and liabilities of the LLC- the only risk for a member if the business fails, is they lose their investments contributed. However, the LLC does not protect a member who personally guarantees a loan, fraud, or negligent rendering of professional services.
3. Limited Management Liability–The LLC manager is not liable for the debts of the LLC as long as he or she acts within the scope of their duties, and does not commit fraud or sign a personal guarantee for a loan.Contrast this to a partnership whereby all the general partners have exposure to the debts and liabilities.
4. Privacy–In certain states, the identifying information of the members of the LLC, is not part of public record.
5. Raise Capital–For purposes of raising capital the LLC is the business entity of choice, because it allows for different levels of ownership with preferred returns to facilitate in structuring deals. However, the selling of ownership in an LLC is not as simple as a corporation. One must keep track of their tax basis or blended basis ( Rev. Ruling 84-53). This requires a competent CPA because the tax and blended basis is a most complex area of the tax code.

When an LLC Should Be Considered

1. You want to limit your personal liability from your operational business: The use of the operating agreement will assist in limiting your personal liability for the actions of your partner–this is referred to “inside liability”. The  LLC is preferred here to the general partnership type of entity.
2. You want to limit your personal liability from an investment property: Here with the use of an LLC, you can accomplish this goal.
3. Your business and its associated value are at risk of estate tax consequences upon your death. Here, the LLC has become a popular alternative to the Family Limited Partnership entity. During your lifetime, you transfer ownership of your business to your beneficiaries of a trust for their benefit, and still retain control and management of the business until your death. Although the Federal Estate Tax exemptions are quite high, there are a number of states whose estate tax exemption is relatively low.
4. You own assets and want to shield them from creditors. This refers to “outside liability” and greatly depends on individual circumstances, and the state you reside. In some states, the only remedy a personal creditor can use to pursue income and assets of an LLC that you own is to get what is called a Charging Order from a judge. This means that the personal creditor must wait for the LLC to distribute income to you. Other states have provisions to foreclose on your LLC ownership, and other state can force dissolution of the LLC. Therefore, be aware of these important nuances of the LLC.