Why is this Topic Important to Financial Professionals? Look in most local business journals that report on the formation of new business entities and you will see 95% of new businesses are formed as an “L.L.C.” This company structure is the primary one for entrepreneurs, professionals, and small businesses. However, after twenty years of significant usage, many questions about this form of entity are still novel. The financial professional should be able to explain to a client the basics of the Limited Liability Company.
What is an LLC?
Limited Liability Companies (commonly called “LLCs”) are state statute sanctioned legal business entities. The business entity is similar to a limited liability partnership except that it has members and not partners (no need for general partners). Moreover, some states allow for only one member, known as a single-member LLC, an option not available in partnership entities that require at least two partners. The members can be persons but may be other business entities, such that an LLC can be a member of another LLC.
The LLC can be established and managed so as to offer the benefits of a corporation such as limited liability and continuation after a member’s death, but without the impact of corporate taxation.
What is the benefit of an LLC?
The LLC properly managed provides for the protection of personal financially liability in connection with the business liability. Proper management generally includes following the annual requirements of corporation law, such as holding an annual directors and members meeting, and recording corporate minute (this will be discussed in future blogticles).
Additionally, the LLC avoids double taxation because of it can elect to be a “pass-through” entity for federal and state tax purposes – like a partnership or a sole-proprietorship is treated.
Also, most LLCs do not have a restriction on the number of members as S-Corps have (albeit rarely will the number of members or shareholders be an issue for a financial professional’s client). To learn more details and nuances of each business structure see the AUS Main Section 10. Basics Of Business Insurance, A—Forms Of Business Organization. More detail on LLCs specifically is provided in AUS Main Section 14.1, I—The Limited Liability Company (LLC).
What are some limitations of the LLC?
Aside from the fact that LLCs have essentially developed as a hybrid of older forms of business organizations, and are relatively new in the history of corporation law. The LLC is not a corporation in the traditional sense of the word.
Sometimes businesses start as an LLC but expand to a point of eventually considering receiving outside equity with the goal of a public offering such as listing on a stock exchange. The LLC is not suitable for “going public”. Thus at the stage of soliciting equity investment for a business a client may have outgrown the LLC and should convert into a C-Corporation (a topic that will be addressed in a future blogticle).
The Federal Government allows the business owner(s) of the LLC to choose how the LLC will be characterized for tax purposes. The LLC may be taxed as a Corporation (both Subchapter C and S), partnership or sole-proprietorship. This process is generally referred to as “Check the Box”.[1] The IRS Check the Box Form is Number 8832[2] and the business owners literally check one of the included boxes on that form and then file the corresponding tax returns.
What are some other uses of LLCs?
LLCs are used in many transactions by high-net worth client. Sometimes clients use an LLC in place of a trust in the irrevocable life insurance trust (commonly called an “ILIT”) structure. By example, in a situation where a client wants less restriction on the direction of the assets of the vehicle, the LLC is a more popular choice than the ILIT. As a result, the LLC has become a common tool for the financial planner. A detailed discussion of one of these transactions is examined in the AUS Main Section 14.1, I-The Limited Liability Company (LLC). “LLC as an Alternative to a Life Insurance Trust”.
For a detailed analysis of the tax and non-tax Advantages of a Close Corporation see AdvisorFX Main Library Section 14. Close Corporations I—The Limited Liability Company (LLC) http://www.advisorfx.com/articles/f14_1_2_2080.aspx?action=13
Tomorrow’s blogticle will address Accounting for Corporations and Limited Liability Companies and How it Relates to Insurance.
[1] Treasury Regulations Section §301.7701-3.
[2] Internal Revenue Service Form 8832, http://www.irs.gov/pub/irs-pdf/f8832.pdf.
William Byrnes' Tax, Wealth, and Risk Intelligence 