BUSINESS SERVICES -
INCORPORATED OR LIMITED LIABILITY COMPANY
TO INC., OR TO LLC, THAT IS THE QUESTION!
LLC Benefits:
» Personal liability
limited to the amount invested.
» Flexible management
control & design.
» Federal tax stauts
equivalent to a sub-S corporation.
For many years now there have been three basic business structures;
the solo practioner, partnership and corporation. The Limited Liability
Company ("LLC") is a cross between the partnership and corporation.
Due to recent enactments in the U.S. it is just now becoming popular,
and in Pennsylvania, it is just now becoming possible, to form an LLC
though this form of ownership has been available in Germany, France and
other countries for some time. While offering its operators the same personal
protection from liability as a corporation, it retains the flexibility
of a partnership to define its own management structure, rules of procedure,
voting rights, distribution of profits and losses, and other structural
elements.
The LLC allows great flexibility among its members to create the elements
of the structure of the company in a way that best suits their profit,
loss and tax needs while retaining protection from personal liability.
Through an Organization Agreement, the LLC allows its members and managers
to grant themselves extensive protections. Unlike a partnership, there
is no requirement to state a duration in the Certificate of Formation,
yet members may limit their liability to their investment in the company.
LLCs must register with the Secretary of State. » to
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Corporate Comparison
The LLC provides its members with liability protection and tax treatment
similar to that of stockholders in a S Corporation. While a S Corporation
is subject to additional statutory restrictions, the LLC is not. For
example:
» The LLC is not
limited to one class of stock ownership.
» The LLC does not
have to be domestic.
» The LLC may have
more than 35 members.
» The members may
include other corporations, nonresident aliens, partnerships, trusts,
pension funds and charitable organizations.
» The LLC may have
subsidiaries.
A Sub-S corporation may generally not have any of the above. Consequently,
the LLC flexibility provides more freedom to plan distributions and allocate
profits and losses.
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Limitied Partnership Comparison
The LLC is taxed very similarly to a limited partnership. While a limited
partnership is subject to additional tax limitations, the LLC is not.
For example:
While a limited partnership must have at least one general partner who
is liable for partnership debts, all of the LLC members may be protected
from liability.
If limited partners participate in the management of the partnership they
may lose their limited partnership status and limited liability protection.
The participation of LLC members does not negate their limited liability
status which enables the members to be principal participants in the activity
of the business without the associated liability.
Accordingly, LLC members may "materially participate" within
the meaning of Section 469 of the Internal Revenue Code, which limits
passive activity credits and losses, and still maintain limited liability
protection.
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When Is an LLC Appropriate?
LLCs have been and are being formed for: Family
Business Enterprises: Member control is clearly outlined in the
Agreement. Estate planning considerations can be customized as an essential
component of the agreement. With the proper structure, pass-through tax
treatment can be achieved.
Venture Capital, Real Estate & Other Investments:
Control, division of authority, responsibility, profits and losses can
be established with great discretion and creativity.
Start-Ups: Can obtain the pass through benefits of
the Sub-S without the restrictions on ownership that so often cripple
a new business. Capitalization is more easily obtained because there is
no limit on the number of investors.
Professional Corporations: Accountants, attorneys, doctors,
psychologists, financial planners and other professionals can disassociate
themselves from partner liability associated with their partnership by
switching to an LLC yet maintain the same control as in a partnership.
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How Do I Form An LLC, and Can I Do It Alone?
Members of an LLC contract in writing with each other to form the Agreement
of "Constitution" of their LLC after formal registration of
the LLC with the Secretary of State of Pennsylvania, or the forming state.
This Agreement may be called many things such as the "Company Agreement"
or "Articles of Organization."
The Agreement clearly sets out the goals and business objectives of
the LLC, voting rights and restrictions, restrictions on access to information,
management rights, distribution hierarchy for profits and losses, and
any other critical provision necessary for the success of the LLC deemed
appropriate by its members. While there are some state imposed restrictions
the originator should be familiar with, almost any other provision, element
or restrictions can be included giving the drafter great opportunity to
be creative to meet the company's objectives. However, once written, the
LLC can then only be changed by unanimous consent and so sufficient initial
consideration to the elements is critical.
With great flexibility comes responsibility, enter the Internal Revenue
Service. Being the "Service" that they are, they have stated
a position and provided a test to determine whether they will treat any
given LLC as a partnership or a corporation. Since pass-through tax treatment
is generally a primary reason for having an LLC, be sure and review your
proposed plan with an attorney or an accountant. [CFR 301.7701-2, -3 &4].
The LLC Agreement is a complex document, equally if not more so than
a partnership. Do not try this at home alone, or anywhere else on your
own. The Agreement will require originality and creativity and still comport
with other basic legal principles to provide you with the control and
tax flexibility and still maintain the limited liability protection.
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How Do I Determine If I Should LLC?
You do not want to LLC if:
You are planning to operate your business in a state that does not recognize
LLCs. The consequent loss of exepcted limiations on liability can be overwhelming
and unnecessary.
Entrepreneurs who do not want the cost and constraints of any organized
structure and need to preserve the autonomy that come only with the sole
proprietorship; or, need the time-honored rigid form of the typical corporation.
Sole proprietors. An LLC requires two or more people.
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LLC Benefits In Certain Situations
Because the IRS has recognized the LLC for taxing purposes as a partnership,
it is not exposed to the typical double taxation problems associated with
corporations. Further the LLC can separate income and expenses between
owners in the same way as a partnership, avoid the 35 member limit and
other restrictions of the Sub-S corporation.
If you have a Sub-S, you can avoid the risk of the IRS suddenly you
have violated its status and change your taxable rates by becoming a LLC.
Or, you can use a LLC in combination with your existing corporation.
For example, if your corporation conducts an active business but also
owns real estate, you can have the LLC own the building and rent it to
the corporation. The corporation pays lease payments to the LLC which
then becomes taxable income to you. But, this is rent income, not salary
from the business and so it is an expense to the corporation and not doubly
taxed. Further, since it is rent income, you don't have social security
tax to consider for this income stream. Of course, it is passive, and
will require passive offsets to reduce the tax liability. With the building
owned by the LLC, you now have limited property owner liability which
may result in some savings on liability insurance premiums.
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