Limited Liability Companies and Family Business

By Brown, Elizabeth K. | THE JOURNAL RECORD, August 26, 1999 | Go to article overview

Limited Liability Companies and Family Business


Brown, Elizabeth K., THE JOURNAL RECORD


Have you noticed that many new businesses are being formed as limited liability companies instead of corporations or partnerships?

Have you wondered what the reason is for the change?

Have you wondered whether you should explore the possibility of using a limited liability company in your family business?

In recent years, the use of the family LLC has become increasingly popular in the business world as the entity of choice, surpassing the corporation and the partnership.

The reasons for its popularity include that it provides asset protection to the owners of the LLC, has income tax advantages over the corporate form of business and is a convenient vehicle for effectuating a succession plan including giving assets to family members.

Until 1992, there was no such thing as a limited liability company in Oklahoma. Other states had experimented with the concept of creating a business entity that combined the best features of a corporation and a partnership.

In 1992, the Oklahoma Legislature decided to create this new type of business entity and enacted a statute governing its existence and characteristics. Since that time, thousands of new Oklahoma LLC's have been formed.

The reason for the limited liability company boom is the advantages that the LLC provides over both corporations and partnerships.

Like a corporation, the LLC has the corporate characteristic of providing a liability shield to the owners of the business. Generally, as with a corporation, the creditors of a limited liability company cannot reach the assets of its owners.

For example, if the LLC operates a retail business and a customer slips and falls in the store, the customer may be able to recover from the assets of the LLC, but should not be able to recover from the assets of the LLC owners.

Like a partnership, the LLC provides asset protection to the business itself from the claims of a creditor of the owner of the LLC. While a creditor of a shareholder of a corporation can obtain a judgment against the owner and levy on the stock of the corporation, a creditor of an owner of an LLC can only obtain a charging order against the owner's interest in the LLC. A charging order only entitles the creditor to receive the owner's share of distributions from the LLC when made and does not entitle the creditor to become an owner of the LLC or to any voting rights in the LLC.

This asset protection aspect can be quite advantageous to the business owner when the business owner has creditor problems of his own.

For example, if the LLC owner has an outstanding judgment against him personally for $25,000, his judgment creditor would not be able to take his ownership interest in the LLC to satisfy the judgment. Instead, all the creditor would be entitled to receive is the distributions that are made from the LLC to the owner.

Since oftentimes no distributions are made to owners of closely held businesses and instead the profits are reinvested in the business, a creditor of an LLC owner may not be able to collect on any part of his judgment against the LLC interest.

Another advantage of the LLC is that it generally is a flow- through entity for income tax purposes since it is taxed as a partnership.

Many family-owned businesses historically have been operated through a C corporation, which is a separate taxable entity. The problem with the C corporation is that dividend distributions are not deductible by the corporation, so there is the possibility the corporate earnings could be taxed twice before they reach the owner's hands, once at the corporate level and again at the shareholder level when dividends are paid. As a flow-through entity for income tax purposes, the LLC reports its income on a separate income tax return but pays no income tax. Instead, each owner of the LLC reports his or her prorata share of the income from the LLC on their separate individual income tax returns. …

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