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Explanation of LLCThe minutia of the law is such that we often lose the forest for the trees. In this article, we try to step back and see the big picture by providing an explanation of the LLC. The limited liability company [“LLC”] is a fairly recent creation. It is not a federal creation, but a state one. It arose in the late 1970s when the State of Wyoming of all places came up with the idea. The goal was to create a business entity choice that was tailored to small businesses and brought in some much needed revenue. Most other states ignored the LLC until the late 1980s. What made them all jump on the bandwagon? The IRS. The agency issued a ruling indicating that it would allow an LLC to be classified as a partnership for tax purposes. This was a huge brake because it created a business entity that had the best aspects of a corporation as well as the best of a partnership. For once, the various governments had done something right! The early 1990s saw a mad rush by the various states to pass LLC legislation. The entity is now available in every state and is considered a quality choice for most small businesses. Why? Well, the owners of an LLC cannot be held personally liable for its debts. Even better, the owners don’t have to jump through a host of meetings and what have you to administer the entity as is usually the case with corporations. From a tax perspective, the double taxation could be avoided by designating the LLC as a partnership for tax purposes with the IRS. It was the proverbial win-win and still is in many cases. Are there any downsides to an LLC? Yes. One has to do with the cost. States have often overburdened the LLC with fees and costs. In California, for instance, you must pay an $800 minimum franchise fee each and every year you are in business. Many states have similar fees, but may call them something different. An additional downside of the LLC is a tax situation that arises for those who are single owners. The problem is the entity is not recognized by the IRS. You can only designate the LLC as a partnership for tax purposes if there are two or more owners. When there is only one, the IRS considers the entity to be a sole proprietorship. This means the taxes are reported on a Schedule C of the owner’s tax return and self-employment taxes must be paid. As this explanation of the LLC hopefully shows, the entity is a good choice in some situations and a bad one in others. Still, it is a welcome addition to the more traditional forms of business such as corporations and partnerships. ******************* Nothing in this article is intended to create an attorney-client relationship. Please contact me if you have any questions. |
