LLCs have been heavily advertised over the last decade, “The new, best, structure to protect you, your business, and your assets,” promoting the golden triad of: liability protection, tax savings, and privacy. ‘What’ is the truth about LLCs? ‘When’ would it be appropriate in your business plan? Also, ‘Why’ is it being so heavily “sold”. Limited Liability Companies have joined the ranks of chartered business organizations, such as the venerable C-Corporation, the one-time popular Limited Partnership, and the waning Sub-S corporation. Also in our list of contestants is the ever popular sole-proprietorship, and the always dangerous Partnership or General Partnership. Incfile review
The LLC is the proverbial “New Kid”. Let’s make an in depth review of the relative strengths and weaknesses of an LLC. For this article we are going to limit our scope to three specific areas, Tax Treatment, Limitation of Liability, and Privacy. These seem to be the most common reasons that people consider LLCs.
Tax Treatment: The LLC may not pay its own taxes, (That is the intent, however, unless specific protocols are followed, the LLC may be required to pay taxes as a corporation.) It does file a tax return, which is merely a profit or loss statement, and then distributes the proceeds to the members in proportion to their percentage ownership. The members then pay taxes on this ‘passive’ income on their personal tax return. This is similar to how a sub-S corporation’s stockholders receive dividends. A C-Corporation on the other hand actually pays its own taxes, and at a much more favorable rate than an individual. As an example let us assume that you are the sole owner of your business. You are advised to take a minimal amount of money out of your business as regular payroll (lets say that ideal amount is $30,000). This will allow you to have enough income to satisfy the IRS requirements, maximize your personal 15% tax rate, and to cover all of your personal deductions. The rest of the profit, will be handled as a function of the type of business. In all of the “Pass-through” entities (Partnership, LP, Sub-S Corp., and Limited Liability Company), all of the money is passed to you at the end of the calendar year. You then pay taxes immediately at your personal tax rates, At least 25%, or 28%, or even 35% federally, and State taxes may be a concern. However, if your business were a C-Corporation, it would be paying its own taxes, Federally, 15% on the first $50,000 of profit. That’s 80,000 total dollars at 15% or less. Even above $50,000 the taxes for corporations are better than personal. The federal tax on the first $100,000 is only 22¼%, on the first $200,000; less than 31%, and the maximum effective tax rate is 34%. Yes, you can transfer all of the profit from an LLC directly to your bottom line. . . but why? Why would you want to pay taxes at your higher personal tax rate? Double taxation? In our research we have only found one area that would be subject to “Double Taxation”, that is “Dividends”. Double taxation occurs when the corporation, at its year-end, declares a profit, (Pays its taxes on that profit) then distributes the profit to the stockholders in proportion to their ownership (And they pay their taxes).
In theory an owner of a corporation could stupidly pay dividends to himself. However, “The normal method of operating a controlled corporation is to distribute earnings in a deductible way. Compensation, retirement benefits, automobile allowances, employee fringe benefits-all are consistently employed to use up the earnings of a corporation. The double tax in most corporations is a hypothetical specter. In addition here are a couple other tax ramifications of Limited Liability Companies: The IRS has determined that a Limited Liability Company can possess enough corporate characteristics to be classified as a corporation for federal tax purposes. It is unclear whether membership interests are “securities” for purposes of the federal securities laws.
In this article we have examined the Tax Effect of the Limited Liability Company. From a tax standpoint clearly either: the LLC will have no taxable benefit, or will have a yet undetermined effect on taxes. This will depend on the specific determination of your LLC by the IRS (When was the last time they made a determination that was good for you?) We are testing the hypothesis that the Limited Liability Company is a good business entity; To reduce taxes, to shield the owner from liability, and to provide privacy. We found, regarding taxes, the Limited Liability Company is either not a tax benefit or an “Unknown”. The general determination of the IRS is that it will be taxed as a Partnership. We know that a partnership is not a tax advantage. We also have learned that some exceptions can be applied that would cause the LLC to be taxed as a Corporation.
Let us consider the other reasons that people have been encouraged to create an LLC; Liability Protection and Privacy. Liability Protection: The LLC was intended to provide the pass-through tax treatment of a partnership while still allowing the liability protection of a corporation. While this idea of choosing options from a Chinese Menu for your business structure sounds appealing, it defies what we know to be true about the judicial process. This country’s entire infrastructure is predicated on the idea that an independent third party shall define the terms of existence for you and your business. Each lawsuit has a loser. Every court case denies someone of something that they claimed to be rightfully theirs. Merely claiming the right to a tax benefit and denying the responsibility for liability does not make it so. The courts use “precedence” to determine the viability of claims. Regarding Limited Liability Companies, there really is no substantial precedence.
Thirty, forty, fifty years from now we may know how the courts will treat LLCs, but right now, we can only consider related rulings. Therefore, let us, as the courts do, draw upon rulings from related areas, and consider some potential arguments. The IRS has made a ruling: “The Limited Liability Company will initially be taxed as a general partnership.” Now listen to the voice of the opposing attorney. “Your Honor, the defendant intentionally organized his business, not as a Corporation which has a long history, and much precedence, regarding protection from liability, but as an LLC.” “Your honor, the IRS says that for their purposes, the LLC is synonymous with the General Partnership.” “If the IRS classifies the LLC as a partnership, without any precedence to the contrary, then we must also.” “Therefore, since this is a Partnership, all liability for all debt, rests on all of the members.” Not a very comforting thought if you have a lot at stake. You may be able to argue the other way, and win, but it would probably be better to avoid the argument altogether, and let someone else test the waters.