Academic journal article Journal of Accountancy

The Pros and Cons of LLCs: This Popular Entity Choice Serves a Wide Variety of Purposes

Academic journal article Journal of Accountancy

The Pros and Cons of LLCs: This Popular Entity Choice Serves a Wide Variety of Purposes

Article excerpt

The use of the limited liability company (LLC) has mushroomed in popularity over the past two decades. IRS statistics show a 66% increase in domestic LLCs between 2005 and 2014, and in 2004 LLCs were already popular entities. The core reasons for their attractiveness for a wide range of business purposes are well-known: chiefly, passthrough tax treatment while offering their owners limited liability similar to that of a corporation. CPAs may be less familiar, however, with some of the other nontax features of LLCs and instances in which forming one may not be advisable. What follows is an overview of some of these features that help explain the ascendancy of LLCs but also their limitations, as well as some innovative uses of the form that are still developing.

LLCs are entities formed under state law that give the owners liability protection while avoiding the double taxation inherent in C corporations and the ownership restrictions of S corporations. Where partnerships have partners and corporations have shareholders, LLCs have members. All states presuppose at least one member, but there is no upper limit on the number of members.

The United States is unusual in that it has no national business entity law. Instead, each state has the power to create whatever types of business entities it wants to. There was a time when only one state, Wyoming, had an LLC statute. How to classify Wyoming LLCs for tax purposes was unclear, since the Internal Revenue Code did not (and still does not) provide any rules for classifying or taxing LLCs. Eventually, the IRS created regulatory default rules (sometimes called the "check-the-box regulations") under which LLCs with two or more members are normally taxed as partnerships, while LLCs with one member (called a single-member LLC) are disregarded for tax purposes (i.e., taxed as a sole proprietorship, if the sole member is an individual) (Regs. Sec. 301.7701-3(b)). These regulations led to a rapid enactment of LLC statutes, and now all states have LLC legislation. Federal tax classification has no impact on substantive state LLC law and does not, for example, affect the viability of the LLC liability shield.

Because it is possible to elect out of the default rule and have an LLC taxed as a C or S corporation, it is even common for taxpayers to form LLCs when they want corporate tax treatment. Typically, they elect to be taxed as an S corporation, but in light of the 21% corporate rate for tax years after 2017 instituted by P.L. 115-97, known as the Tax Cuts and Jobs Act of 2017, we might see more LLCs elect C corporation tax treatment. The main reason LLCs are preferred to state-law corporations is that they have a more modern statutory architecture, discussed below.

UNIFORMITY AND COMPARISONS WITH OTHER ENTITIES

If each state had very different business entity laws, life could quickly get very complicated for interstate business. For that reason, uniform statutes have been developed by the Uniform Law Commission. A substantial majority of states have adopted (typically with some minor adjustments) various uniform acts, such as the Uniform Partnership Act and the Uniform Limited Partnership Act.

The Uniform Law Commission has produced two uniform LLC statutes. The first of these was not widely adopted. As of this writing, the second, often called the Revised Uniform Limited Liability Company Act (RULLCA), has been adopted in 18 states and the District of Columbia and is being considered in another state. While the LLC statutes in the states that have not adopted RULLCA tend to be fairly similar, and RULLCA usually does not represent a radical departure from what is typical, there can be important differences among statutes. However, all LLC statutes have the same liability shield.

Liability shield

LLC members, in their capacity as members, are not liable for the LLC's obligations. This is effectively the same liability shield that corporate shareholders have. …

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