A LIMITED Liability Company (LLC) is a new form of hybrid business association that combines the advantages of a corporation with the flexibility of a partnership. Let’s explore the advantages & disadvantages of this popular entity.
Advantages of LLCs
1. Liabilities are limited to the equity invested by each member.
2. It gives some form of liability protection for each member unlike general partnerships whose partners are also exposed personally to liabilities of all other partners.
3. There is greater flexibility in management, capital contributions, and distributions.
4. There are liberal membership qualification requirements.
5. It provides for step-up of a decedent’s inside basis of the member’s portion of LLC assets.
6. The liquidation of an LLC is generally treated as a tax-free event.
Disadvantages of LLCs
1. The statutes on LLCs are relatively new. It is still unclear how Tax Courts will rule on different issues.
2. There is confusion because different states enact different rules.
3. Most states require that LLCs dissolve upon death, retirement, expulsion or bankruptcy of any member unless all remaining members consent to reinstate the LLC.
4. Most states require that an LLC must have two members (as opposed to only one for corporations).
5. California LLCs must also pay an annual fee based on the company’s gross income. Yes folks, gross income. While other states welcome this new type of organization, it seems that California was only forced to adopt LLCs statutes to stop the outflow of business into the neighboring states of Nevada and Arizona. That attitude manifests itself by making this type of entity available but punitive by taxing your gross rents and your sales price when you dispose of it. See updates below.
As you can see, there is a need to plan, a need to balance the advantage of liability protection against the added burden of an entity fee. LLCs who check the box to file as partnerships or disregarded entities gain some asset protection benefits but find themselves paying fees than other forms of entity.
Here are some TIPS for you:
1. Instead of having one LLC whose gross revenues exceed $250,000, set up multiple LLCs to go under the radar.
2. Consider having multiple FLPs with a common LLC that serves as a general partner.
3. Caveat: Be careful not to trigger a county tax reassessment when you transfer real estate.
4. One way to avoid reassessments is to transfer shares inside the LLC. This also avoids the headache of drawing deeds every time you make a transfer of ownership to the younger generation.
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Victor Santos Sy, CPA, MBA, provides professional services in accounting and tax controversy including IRS audit defense and offers in compromise. He also advises clients on choices of entity including corporations for small businesses and LLCs for rentals. Vic worked with SyCip, Gorres, Velayo (SGV – Andersen Consulting) and Ernst & Young before establishing Sy Accountancy Corporation at 704 Mira Monte Place, Pasadena, CA 91101. The firm celebrates its 35th anniversary this year. You may email tax questions to Vic at [email protected]. You are welcome to visit our website for more than 300 tax tips at www.victorsycpa.com.