Limited Liability Companies

Since 1988, interest in a new type of business entity, the Limited Liability Company (LLC), has increased all over the country. This interest was magnified due to an IRS ruling that an LLC can enjoy the same tax flow status as a partnership. In addition to this benefit, a Limited Liability Company can provide the same limited liability for its members as is provided by a corporation.

Thus a LLC is a hybrid - a combination of a corporation and a partnership. This is an advantage over an "S" corporation when the entity cannot meet the requirements of an "S" corporation but desires the advantages of the tax pass-through.

The LLC was originally created by statute in Wyoming in 1977. It has since been accepted in all other states. Each individual state however, treats an LLC differently. For a Nevada Limited Liability Company (LLC) the law simply states that members are limited in their liability, whereas in California it states the same and then goes on with a page of exceptions.

Recently, the U.S. Internal Revenue Service has amended rules pertaining to LLCs. Now, an LLC is no longer required to avoid two of the four corporate characteristics. Those being:

1. Limited Liability

2. Centralized Management

3. Relatively free transferability of interest

4. Continuity of life

What are some of the advantages of an LLC? Advantages include:

1. Income can be spread to family members to lower your income tax.

2. An LLC is not limited to 35 shareholders (as in an "S" corporation).

3. The LLC limits the liability of its members.

4. Profits of an LLC do not need to be distributed according to percentage of ownership. Example: 4 owners with 25% ownership each but only 2 of the owners are actually working the business. The Operating Agreement can written so that the 2 working owners receive 80% of the profits while only owning 50% of the business.

What are some of the disadvantages of an LLC? Disadvantages include:

1. It is a relatively new entity and there is not enough case law to determine how the courts will treat an LLC.

2. Interests are not freely transferable.

3. LLC's are treated differently in different states.

4. Lifetime may not be limited but if you chose this feature then to be taxed as a partnership you will have to give up either the limited liability characteristic or the centralized management characteristic for this reason most people chose a lifetime of 30 years.

5. Lack of privacy (all income reported on personal income tax).

6. C-Corporations have many tax write off's that an LLC does not. One example of this is the Medical Reimbursement Plan that a C-Corporation can utilize while LLC members are not allowed to. This can result in very significant tax savings.

A Limited Liability Company is an area of developing law and it will take a few years to firmly establish the rules and laws governing them. In the meantime, they do have their place but much thought needs to go into the decision to use an LLC over a corporation.

Next: C-Corp vs LLC vs S-Corp

Related: Why form an LLC in Nevada?

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