Magazine article The National Public Accountant

Limited Liability Companies: Best of Both Worlds

Magazine article The National Public Accountant

Limited Liability Companies: Best of Both Worlds

Article excerpt

Limited liability companies (LLC) provide a new business organization alternative for investors. LLCs blend favorable features of corporations and partnerships while attempting to minimize the disadvantages of each.(1)

If appropriately structured, an LLC preserves the limited liability feature for member-investors (typically associated with a corporation), while permitting taxation similar to a partnership. Statutes authorizing the creation of an LLC are separate and distinct from those governing incorporation of corporations.

Background

This structural form of business has existed in many European, South American(2) and African countries but has only recently become popular in the U.S. Wyoming was the first U.S. state to adopt an LLC statute in 1977.(3) Florida saw LLCs as a mechanism for attracting foreign investment and adopted an LLC statute in 1982.(4) However, it is only since the 1988 IRS ruling that recognized partnership-like taxation of a Wyoming LLC(5) that this hybrid form of business organization has become popular in the United States. By the fall of 1994, at least 45 states had adopted statutes authorizing the domestic creation of LLCs,(6) and LLC bills had been introduced in additional states. Most states have statutory provisions recognizing foreign LLCs doing business in their states, even if the state has not authorized the domestic creation of an LLC.(7) Delaware,(8) Colorado and Wyoming have emerged as model states for alternative forms of LLCs.

Taxation of LLCs depends on the combination of structural features of the LLCs. An LLC may be taxed like a corporation or with pass-through taxation similar to that of a partnership. Most businesses electing an LLC form of business do so to take advantage of the partnership-like pass-through taxation of income and losses feature. To attain partnership-like taxation, the LLC structure cannot include more than two of the following key corporate characteristics:

* limited liability;

* continuity of life;

* free transferability of interest; and

* centralization of management.(9)

Assuming the business seeks limited liability for its investors (known as members) and flexibility in management structure, the parameters for restricting continuity of life and transferability of interest must be observed.

Who Should Invest in an LLC?

LLCs are well-suited for start-up businesses (as they are not affected by the tax implications that result from conversion from other forms of business to LLCs). Other small closely held businesses can often benefit from the ability to retain both a voice in management and limited liability for investors. Small retail establishments and some service businesses(10) (such as construction firms and home repair businesses) may find this a convenient combination.

LLCs pose a popular alternative for venture capital firms, oil and gas ventures and ESOPs (employee share ownership plans). Joint venture investors can achieve limited liability for all investors, without having to designate a general partner in the traditional limited partner arrangement. In addition, flow-through taxation treatment in an LLC eliminates the 80% control requirement needed for consolidated corporate returns.(11)

LLCs are particularly appropriate for real estate investments. If a corporation owns real estate that appreciates in value and later decides to divest itself of that real estate, a section 311 Federal gain tax must be paid. An LLC can own land and lease it to a corporation without such negative tax risks, and depreciation of the asset can flow through to investors. Land already owned by a corporation cannot be transferred to an LLC without tax gain, however.

Where permitted, LLCs may also be used for professional services, insurance and banking (investment banks and savings and loans). Although LLC structures are not sanctioned for banking and insurance industries in several states,(12) some professions are allowed to choose LLC structures. …

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