Nearly every state has passed legislation allowing businesses the choice of operating as limited liability companies (LLCs) or limited liability partnerships (LLPs). LLCs combine the characteristics of corporations and partnerships, making their a viable tool for CPA firms. LLCs limit members' personal liability exposure like a corporation and, if properly structured, may receive the beneficial federal tax treatment of a partnership.
LLPs generally provide less liability protection to members than LLCs. Innocent partners in LLPs may be protected from personal liability for the negligence and malpractice of other partners, but in the case of ordinary commercial debt, members of an LLP may not be protected. However, it may be easier for a CPA firm to convert to an LLP and gain the added liability protection without a lot of red tape.
For CPA firms, forming either an LLC or an LLP is particularly attractive--in the wake of business failure CPA firms often are the targets of lawsuits. Because there is no single form of practice that will meet the needs of all firms in all states, CPAs choosing an organizational structure should understand the various forms of business entities available. They should know how state laws treat these forms of business entities and know the form that best meets their objectives.
Limited liability companies
LLCs offer limited liability to all firm members and are treated as partnerships, not as corporations, for federal income tax purposes if they do not have more than two of the following corporate characteristics:
* Limited liability protection.
* Free transferability of interests.
* Continuity of life.
* Centralized management.
Becker Rutledge, member of Marcus & Rutledge, LLC, in Metairie, Louisiana--the first CPA firm in Louisiana to become an LLC--was a sole proprietor who, after joining with John Marcus, chose to form an LLC for the ownership flexibility and the limited liability it provides members. "You know yourself, and when you form a business organization with other people you hope you know them, but there are always surprises lurking that make members vulnerable in a general partnership. We chose to form an LLC because each member would be protected against the professional liability of the other members," said Rutledge.
In most states, LLCs are formed by filing an articles of organization with the secretary of state and by paying the requisite filing fee. "It is very inexpensive for us to be an LLC," said Rutledge. "We filled out the form ourselves, and our state fee was $60. Of course, if you want to do anything different from what the state legislation's default provisions provide, you may want an attorney to create your operating agreement."
How safe is an LLC?
As of May 1995, an LLC's risk protection had not been tested. "The state courts have not ruled on whether an LLC is effective in insulating the members from the risks in the business," said Bryan P. Collins, partner of Arthur Andersen & Co. in Washington, D.C. Collins also said in some cases owners of an LLC could be subject to higher individual federal or state tax rates as well as self-employment taxes. "Once you have accepted that an LLC is to be treated as a partnership for tax purposes, it leaves certain tax questions unresolved on how partnership rules are applied to LLCs."
Limited liability partnerships
For many CPA firms, especially firms already practicing as general partnerships, converting to an LLP is the easiest solution. To register, CPA firms hive only to file a registration form with the state. Also, because an LLP is merely the continuation of an existing partnership, it is not necessary to modify the existing partnership agreement. Some states impose minimum insurance requirements for professionals practicing in LLPs, and some states impose an entity-level tax on LLPs in addition to taxing the individual partners. …