Tax Treatment

LLCs are unincorporated associations that can elect pass-through treatment as partnerships for federal income tax purposes, while, at the same time, providing limited liability to members. Once again, though the rules vary by state; generally speaking:

• LLCs are permitted (under federal law) to elect whether to be taxed as corporations, or to have pass-through taxation.


• Tax treatment for members of a limited liability company may differ, depending on whether the member is a corporation, a partnership, or an individual. Consult the state revenue department and the IRS for particulars.


• An LLC may have no more than two of the following corporate characteristics in order to receive partnership tax treatment:
  
  1. Limited liability
  
  
  2. Continuity of life
  
  
  3. Centralization of management
  
  
  4. Free transferability of interests
• LLCs are treated the same for state tax purposes as for federal tax purposes.

Advantages

The primary advantage of a limited liability company is limiting the liability of its members. If properly structured, LLCs may combine the limited liability protection for businessowners and investors of a corporation with the more favorable tax-treatment of a partnership.

• For federal tax purposes, an LLC allows income to flow to its owners, and the entity is not taxed on its own.


• LLCs provide asset protection from creditors.

LLCs are regulated internally by a members' agreement, which is a non-public document, signed by the members. This document contains the rules and regulations for managing the LLC, and the relationship between members.

Disadvantages

The primary disadvantages are the work involved in, and the expense of, forming an LLC, and recordkeeping requirements after formation. In addition:

• LLCs must have at least two members. S corporations can have one shareholder. Although some states allow single member LLCs, the business is not permitted to elect partnership classification for federal tax purposes.


• Must be carefully organized to ensure partnership tax treatment.


• Not widely used, so corporate shield may not always be upheld in states that do not yet have a limited liability corporation statute.


• Same income tax disadvantages as partnerships.


• Earnings are generally subject to self-employment tax.


• Lack of uniformity in Limited Liability Company (LLC) statutes. Businesses that operate in more than one state may not receive consistent treatment.


• Some states do not tax partnerships, but they do tax Limited Liability Company(s) (LLCs).


• Conversion of an existing business to LLC status could result in tax recognition on appreciated assets.

With this background, we can now turn our attention to the most popular business planning concepts.

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