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  Limited Liability Companies

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Over the past few years, we have been receiving more and more inquiries from clients about the procedures involved in setting up a limited liability company (LLC). 

We're certain that most of you have already heard of LLC's. They are becoming more and more popular and may very well become the preferred type of business organization in the twenty-first century for small businesses.

There are pros and cons to using an LLC and we won't touch on all of those in this article.  If you are considering an LLC, please call us to discuss your particular situation in more detail.

The reason for this is simple. LLC's offer the personal liability protection of a corporation along with the flexibility and tax advantages of a partnership. The personal liability protection means that the members (or owners) of the company cannot be sued for acts of the LLC.

Just like a corporate investor, an LLC member's losses are limited to his or her investment. LLC's also avoid double taxation on distributions or liquidations.

Unlike corporate investors however, LLC members are taxed directly on the gains and losses of the company. Just like with a partnership, the company itself files only an information return with the IRS showing the income distributions to the members. 

While this may sound much like the tax treatment of an S corporation, LLC's actually have greater ownership flexibility and they escape many of the tax restrictions common with S corporations.

TYPE OF RETURN FILED

If you establish an LLC with two or more members, the company will file a partnership return with the IRS and all of the partnership rules will apply. If your new LLC has only you as a single member, the IRS will treat your company as a sole proprietorship and you will file a schedule C with your Form 1040.

If you already have an LLC that was in existence before January 1, 1997, and you have a previously established federal tax classification, you will typically not need to make an election to continue that classification. 

However, if your LLC has only one member and you have been filing as a partnership under the pre-1997 law, your company will now be forced to file as a sole proprietorship and will not be regarded as a separate entity.

CAREFUL CONSIDERATION

If you are looking to establish a new business entity in the near future, you would be wise to discuss the tax consequences with us first. While LLC's are "hot" right now, they may not necessarily be the right alternative for you. Since LLC's are subject to partnership taxation, the buying and selling of LLC interests between members can generate ordinary income to the selling members in many cases.

This is because your ownership interest in an LLC is actually an ownership interest in the "assets" of the company. The gain or loss associated with the sale of those assets to another member can be subject to tax rates of up to 35% on ordinary income. 

Compare that to the much simpler stock transactions between corporate owners which are taxed at capital gain rates of 20%. An LLC may not make sense for you if your company plans to take on many investors who may be looking for an easy "out" down the road.

 

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