The age-old choice of entity in starting a business has al-
ways been a threefold one (except for such oddities as the
"Massachusetts business trust"): sole proprietorship, part-
nership, or corporation. But now there is a new kind of
business entity, which has recently arrived on the scene:
the "limited liability company." All but two of the state
legislatures around the U.S. have enacted laws in recent
years that permit the formation of these new legal entities.
@CODE: AL AK AZ AR CA CO CT DE DC FL GA ID IL IN IA KS KY LA MA ME MD MI MN MS MO MT NB NH NJ NV NM NY NC ND OH OK OR PA RI SC SD TN TX UT VA WA WV WS WY
@STATE has enacted an "LLC" law.
@CODE:OF
@CODE: HI VT
@STATE is one of the two states that has not.
@CODE:OF
Unfortunately, the tax benefits that result from operating
as an LLC have already gotten the attention of Congress, and
a tax-writing committee is said to be looking into the possi-
bility of taking away the favorable tax treatment of LLCs, by
making them taxable as corporations. So be forewarned that
the tax benefits of organizing as an LLC may be taken away
by Congress someday, if LLCs become too popular.
What, you may wonder, is this new entity?
- Is it a corporation? No, not exactly.
- Is it a partnership? Yes, sort of.
- Is it a sole proprietorship? No, not quite.
Starting with the pioneering state of Wyoming in 1977, all
but 2 state legislatures have, in recent years, now passed
laws creating a new type of legal entity called a "limited
liability company" (or LLC). These new entities, which
closely resemble (and are usually taxed as) partnerships,
offer limited liability, like corporations. While it has
long been possible for partnerships to offer limited
liability to their LIMITED partners, a limited partnership
must always have at least one GENERAL partner, who is fully
liable for the debts of the business.
The new "limited liability companies" have, in effect, done
away with the need to have unlimited liability for any of
the owners of what is, in essence, a partnership form of
business organization.
In 1988, in Revenue Ruling 88-76, the IRS concluded that a
Wyoming limited liability company could be classified as a
partnership for Federal income tax purposes (which is very
favorable, from the taxpayer's standpoint, in many cases).
The IRS ruling was based on the following rationale:
. No member has any personal liability for
debts of the company; therefore the company
has limited liability. (Like a corporation)
. The interests of the members are assignable
only upon written consent of all of the
remaining members. (Like a partnership;
however, the Ruling recognized that mere
assignees are entitled to receive profits
and other compensation.)
. The company is dissolved in situations which
are very similar to the dissolution of a
limited partnership. (Like a partnership)
. The company has centralized management.
(Like a corporation)
Under IRS criteria, any entity that has NO MORE THAN two
of the four above features of a corporation is not consid-
ered to be a corporation. Thus because of the absence of
"continuity of life" and "free transferability" of interests
in the LLC entity, the Wyoming limited liability company
These are general partnerships that provide professional
services (such as law, medical, or accountancy firms),
which elect to register as RLLPs and thereby obtain limited
liability. However, as with a professional corporation, an
RLLP will not protect a professional practitioner against
malpractice claims against him or her, or wrongful acts
that are committed by someone acting under his or her dir-
ect supervision or control while rendering professional
services for the RLLP.
An annual fee of $50 per member (minimum fee of $325, maxi-
mum of $10,000) is imposed under New York law on any LLC
(or RLLP) that is structured to qualify as a partnership for
income tax purposes. In addition, such LLCs or RLLPs doing
business in New York City will generally be subject to the
New York City 4% unincorporated business tax. These taxes
tend to detract somewhat from the federal and state income
tax benefits of operating as a non-corporate entity.
@CODE:OF
@CODE: AK
The Alaska LLC law went into effect on July 1, 1995.
@CODE:OF
@CODE: DC
Washington, D.C. has adopted an LLC law, which went into
effect on June 16, 1994.
@CODE:OF
@CODE: CA
California, one of the last holdouts, was the 46th state
to adopt an LLC law, which Governor Pete Wilson signed
into law on September 30, 1994.
The California LLC law contains some interesting and unusual
provisions, not found in other state LLC laws, designed to
make the favored tax treatment of LLCs "revenue-neutral"
under California's budgeting process. The new law imposes
the following special taxes and fees on LLCs:
. MINIMUM TAX -- As in the case of limited partnerships,
an LLC doing business in California is generally free
of any income tax on the entity itself, except for an
annual $800 minimum tax, the same as is imposed on
corporations that have little or no taxable income.
. LIMITED LIABILITY COMPANY FEE -- California also imposes
a special annual fee on LLCs, based on the LLC's "total
income" from all sources, as follows:
For tax years beginning on or after January 1, 1994 and
before January 1, 1996:
Total income (Fee increased
of at least But less than LLC Fee 1-1-96 to 1-1-99)
------------ ------------- --------
$ 0 $ 250,000 $ 0
$ 250,000 $ 500,000 $ 500
$ 500,000 $1,000,000 $1000 $1500
$1,000,000 $5,000,000 $2000 $3000
$5,000,000 -- $4000 $4500
Note that the fees increase for companies with $500,000 or
more of total income in years beginning on or after January
1, 1996, but before January 1, 1999 (right-hand column).
In addition, the above fees may be increased substantially
beginning in 1999, if the state finds it is losing tax rev-
enues from having instituted the LLC form of doing business.
Creating an LLC in California is fairly simple for a new
business, which need only file a one page "Articles of
Organization" form with the Secretary of State (Sacramento).
There is an $80 fee for filing articles of organization of
a California LLC or foreign LLC with the Secretary of State.
The members (owners) of a California LLC should also memor-
ialize their agreement in the form of a written operating
agreement, although (like a partnership agreement) the law
does not require such an agreement to be in writing.
Foreign LLCs (organized under the laws of another state)
must register as such in order to legally do business in
California, and must file Form LLC-5 with the Secretary
of State.
An LLC that is taxable as a corporation in California must
file a California franchise tax return (Form 100) or income
tax return (Form 200). An LLC that is taxable like a part-
nership must file new Form 568.
Note that, for LLC purposes, the California Secretary of
State's office has been interpreting the restriction on
"professionals" very broadly, taking the position that it
applies to all professions licensed or certified by the
state, such as beauty operators, auto mechanics, or real
estate brokers, and is refusing to accept LLC articles of
organization filed on behalf of such businesses, under the
view that they are also professionals and thus not permitted
to operate in LLC form.
Regulated professionals such as attorneys, accountants, den-
tists and physicians are not permitted to operate in the LLC
form in California, unlike many other states that have LLC
laws. However, the 1995 legislative session enacted a new
Limited Liability Partnership law, which allows certain pro-
fessionals to adopt a limited liability partnership (LLP)
entity, similar to an LLC, for professionals, as has been
done in a number of other states. LLPs must register with
the California Secretary of State by filing Form LLP-1. An
LLP, unlike an LLC, is not required to file articles of
organization; normally, it will merely amend the existing
partnership agreement, and file the LLP-1 form.
The California LLP law differs significantly from that of
LLP statutes in most other states:
. Only certain law and accounting firms may qualify for
LLP status, and to do so must either maintain $100,000
of professional liability insurance per licensed person
rendering legal or accounting services (with a maximum
$5 million required for accountants, $7.5 million for
attorneys); or, in the case of accounting firms, confirm
having a net worth of at least $10 million, or for law
firms, meet other financial responsibility requirements.
. The protection afforded members of an LLP is much broader
than under other states' LLP statutes. The only statutory
exception to limited liability for a qualifying law or
accounting LLP is for torts (such as malpractice) commit-
ted by the LLP member himself or herself. A partner in an
LLP is not a proper party to a legal proceeding against
the LLP, unless the partner is personally liable.
@CODE:OF
@CODE: PA
The Pennsylvania LLC law, signed into law by Governor Casey
on December 7, 1994, goes into effect on February 5, 1995.
@CODE:OF
Major benefits of LLC's over the traditional business enti-
ties available up till now include the following:
. Unlike a general partnership, owners of an LLC have
limited liability; and, unlike limited partners in
a limited partnership, they do not lose their limited
liability if they actively participate in management.
. Like a regular corporation (a C corporation), an LLC
provides limited liability to its owners, but taxable
income or losses of the business will generally pass
through to the owners (but may not always necessarily
be deductible, due to the "at-risk" and "passive loss"
limitations of the tax law).
. An LLC is more like an S corporation, in that it pro-
vides for a pass-through of taxable income or losses,
as well as limited liability, but can qualify in many
situations where an S corporation cannot, since an
S corporation cannot:
. have more than 35 shareholders;
. have nonresident alien shareholders;
. have corporations or partnerships as shareholders;
. own 80% or more of the stock of another corpora-
tion;
. have more than one class of stock (or otherwise
have disproportionate distributions); or
. have too much of certain kinds of "net passive
income."
. Also, LLC owners may be able to claim tax losses in
excess of their investment, such as on certain lever-
aged real estate investments, which would not ordinar-
ily be possible in the case of an S corporation or
even a limited partnership.
. LLCs are also much simpler entities to maintain than
are corporations. An LLC is required to file its "ar-
ticles of organization," which are similar to articles
of incorporation, but the operational similarities
tend to end there. It is also a good idea for an LLC
to have a written operating agreement, which spells
out how the company is to be operated, much like a
partnership agreement. However, from that point on,
the LLC is governed by its operating agreement, and
there is generally no need for any of the tedious
corporate formalities such as minutes of meetings,
resolutions and annual meetings of the shareholders
("members" in the case of an LLC). This operating
flexibility, in addition to freedom from corporate
level income tax (except in the few states that im-
pose state income taxes on them) makes the LLC a
highly advantageous form of doing business for the
closely-held or family-owned business.
On the other hand, most of the LLC statutes have certain
built-in disadvantages, as compared to S corporations or
other corporations, such as the fact that LLC's must usual-
ly provide in their articles of organization that the en-
tity will terminate in not more than 30 years, and the fact
that an LLC must (generally) have more than one owner, un-
like corporations.
Even the federal tax treatment of LLCs is no longer uni-
formly favorable. Perhaps unintentionally, a new partner-
ship tax law provision in the Revenue Reconciliation Act of
1993 may adversely impact professional service firms that
are organized as LLCs, rather than as true partnerships.
Under the 1993 tax law amendments, certain payments made
by partnerships to outgoing partners (for "goodwill" or
"unrealized receivables") are no longer deductible to the
partnership, EXCEPT if made to a general partner in a
service partnership, such a a law or medical partnership.
Since LLCs, if properly organized, are treated as part-
nerships for income tax purposes, this new law will apply
equally to professional service firms that are either LLCs
or partnerships....With one important Catch-22: Since an
LLC has NO general partners (all of its partners have lim-
ited liability, like limited partners), then NO payments
(for goodwill, etc.) by an LLC to buy out one of its mem-
bers can qualify as deductible under the 1993 tax law change.
This can be a serious tax disadvantage for a professional
service firm that operates as an LLC, rather than as a part-
nership. (In addition, many states with LLC laws do not
yet ALLOW professional service firms to operate in the LLC
form.)
@IF173xx](@NAME is a professional service firm.)
@CODE: AL AK AZ AR CA CO CT DE DC FL GA ID IL IN IA KS KY LA MA ME MD MI MN MS MO MT NB NH NJ NV NM NY NC ND OH OK OR PA RI SC SD TN TX UT VA WA WV WS WY
One potential drawback of an LLC formed in this state
at present, however, is the uncertainty as to how it will
be treated if it does business in other states (Vermont
or Hawaii) that have not yet adopted LLC laws or recognized
the LLC concept.
Thus, if your LLC carries on business in Hawaii or Vermont,
that state may not recognize the limited liability feature
of such an entity, which could be disastrous to the owners
if your "limited liability" company were to go broke and
the owners were treated like partners in a partnership
(that is, fully liable) in the other state, rather than
being accorded limited liability, as it is in @STATE.
Secondly, other states may not necessarily recognize your
LLC formed outside their state as a partnership-like entity
for tax purposes. This could also result in some serious
tax traps, particularly if distributions by your LLC were
taxed by such a state as corporate dividends, after it
first subjected the LLC's earnings to a corporate-level
state income tax.
Also, some states impose income-based taxes at the entity
level on LLCs, just as for corporations, such as the Michigan
Single Business Tax or the Illinois Personal Property
Replacement Tax, and other business entity taxes such as
in Washington, D.C., Washington (state), and New Hampshire,
also apply equally to LLCs.
@CODE:OF
@CODE: AK FL TX
In fact, @STATE itself treats LLCs as corporations for
purposes of the @STATE corporate income tax law, even
though the @STATE LLC is treated as a partnership for fed-
eral income tax purposes. (There is no individual income
tax in @STATE, so the income of an LLC would entirely es-
cape state taxation if @STATE did not tax its income at
the entity level, which probably explains why the state of
@STATE chose not to follow the federal tax treatment in
this case.)
@CODE:OF
@CODE: CO UT PA
@STATE itself may tax your LLC as a corporation,
rather than as a partnership.
@CODE:OF
Even so, LLC's seem to have many advantages that almost
guarantee a boom in their popularity in coming years.
This may be the first you have heard of Limited Liability
Companies, but it certainly won't be the last. Remember,
you heard it here first....
@CODE: HI MA VT
@CODE:NF
This new entity may have possibilities for companies doing
business in some of the handful of states that have NOT en-
acted limited liability company legislation so far. Just
as companies in many parts of the country may choose to in-
corporate in Delaware, or Nevada, or other states other than
where they actually do business, it may also be possible
in other states to "incorporate" under the Delaware (or
Nevada, Wyoming, etc.) limited liability company provi-
sions. However, since this is a newly developing area of
the law, you would be well advised to consult a competent
business attorney to determine whether your firm will be
able to take advantage of such an out-of-state entity's
special benefits under the laws of @STATE.
One potentially serious problem is that if you create an LLC
under the limited liability company laws of, say, Wyoming, to
carry on business in @STATE, the laws of this state
may not necessarily recognize the limited liability feature
of such an entity, which could be disastrous to the owners
if your "limited liability" company were to go broke and the
owners were treated like partners in a partnership (that is,
fully liable) under the laws of @STATE.
Secondly, non-LLC states may not recognize your LLC formed
outside the state as a partnership-like entity for tax
purposes. Such non-recognition could also result in some
serious tax traps, particularly if distributions by an LLC
were taxed by such a state as corporate dividends, after
it first subjected the LLC's earnings to a corporate-
level state income tax.
Thus, this entity may be best now only for firms that do
business only within states that authorize the creation
of limited liability companies, such as, for instance,
Wyoming, for a company formed under the Wyoming limited
liability company law, or in other states that recognize
