LIMITED Liability Company (LLC) is a hybrid that combines the pass-through attributes of a partnership with the limited liability of a corporation. The owners are called “members” who hold “interests” and are governed by an “operating agreement.” An LLC with more than one member is taxed as a partnership. This is a relatively new form of doing business.
Let’s explore the plus and minuses of LLCs.
A. Advantages:
1. Liabilities of members are limited to their investments in the LLC.
2. No double income tax. No double tax on liquidation.
3. A Limited Liability Partnership (LLP) for professionals allows protection from claims involving the wrongful acts of other partners (vicarious liability).
4. Can specially allocate profits and losses.
5. A member contributing appreciated assets to an LLC in exchange for membership interest is not required to recognize gain on that exchange.
6. Distributions of appreciated property from an LLC are generally received without gain.
7. Receipt of an interest in an LLC for a profit interest is generally not taxable.
8. It is not subject to accumulated earnings tax, personal holdings tax, or alternative minimum tax.
9. It is not required to maintain certain formalities such as corporate minutes.
10. The basis of a member’s interest can be increased by the member’s share of LLC debts.
B. Disadvantages:
1. Each state has its own regulations. For example, California LLCs pay additional annual fee based on gross receipts. This is the main reason why I seldom recommend LLCs for small estates. The annual fee increased every year and has doubled since its introduction until entities challenged the Golden State’s anti-business stance. Others fled the state to other business-friendly neighboring states. It is now permanently set at $900/2,500/6,000/11,790 for gross receipts of $250K, $500K, $1M, and $5M.
2. A member’s net earnings are subject to self-employment tax, whether distributed or not.
3. Loss from the sale of LLC interest is a capital loss (limited to $3000 per year).
4. An LLC will be constructively terminated if 50% or more of total interest is sold or exchanged within 12 months.
5. Disassociation events such as death, retirement or bankruptcy dissolve the LLC unless all remaining members consent to reinstate the entity.
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Victor Santos Sy graduated Cum Laude from UE with a BBA and from Indiana State University with an MBA. Vic worked with SyCip, Gorres, Velayo (SGV – Andersen Consulting) and Ernst & Young before establishing Sy Accountancy Corporation in Pasadena, California.
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He has 50 years of experience in defending taxpayers audited by the IRS, FTB, EDD, BOE and other governmental agencies. He is publishing a book on his expertise – “HOW TO AVOID OR SURVIVE IRS AUDITS.” Our readers may inquire about the book or email tax questions at [email protected].