Limited liability: a business form worth considering.One of the most important and far reaching decisions that an accounting practitioner must make is that of selecting a business form. Alternative forms available have historically been limited to sole proprietorships A form of business in which one person owns all the assets of the business, in contrast to a partnership or a corporation.
A person who does business for himself is engaged in the operation of a sole proprietorship. , partnerships or corporations. The limited liability attribute pushes heavily for the corporation form of organization. However, the resulting double taxation has made many practitioners hesitate in selecting the corporate form. In partial answer to this double taxation disadvantage, limited partnerships and subchapter S corporations subchapter S corporation n. the choice by a small corporation to be treated under "subchapter S" by the Internal Revenue Service, which allows the corporation to be treated like a partnership for taxation purposes. arose. However, these two business forms also have real limitations.
Today, 44 states allow an additional option for business form: the limited liability company (LLC (Logical Link Control) See "LANs" under data link protocol.
LLC - Logical Link Control ). Unlike corporations, LLC members (owners) avoid double taxation since the LLC is taxed as a partnership. LLCs provide the same limited liability as S corporations, C corporations and limited partners within limited partnerships. LLCs could answer the accounting practitioner's need for a superior business form.
LLCs are often better than other business forms. Subchapter S corporations or limited partnerships are often perceived to be sufficient as a business form for practitioners; however, their limitations are real. The subchapter S corporation has limits on both formation and continued operations. The real limit of having a corporate general partner in a limited partnership to reduce liability is avoided since all LLC members enjoy limited liability. Participation restrictions and partner ownership share are irrelevant to LLC members. LLCs offer more favorable fa·vor·a·ble
1. Advantageous; helpful: favorable winds.
2. Encouraging; propitious: a favorable diagnosis.
3. tax attributes then other business forms while avoiding the restrictions.
Limited Liability Company History
The power to formulate formulate /for·mu·late/ (for´mu-lat)
1. to state in the form of a formula.
2. to prepare in accordance with a prescribed or specified method. and regulate artificial entities such as corporations and LLCs is given to the states through legislation. The state of Wyoming passed the first LLC statute in 1977. Other states were slow to follow this initial legislation since the Internal Revenue Service immediately made attempts to tax the new form as a C corporation, nullifying LLC advantages. Other states have now followed, however, especially since the Internal Revenue Service ruling 88-76. This ruling, promogated in 1988, provides that LLCs will be treated like partnerships for taxation purposes. This meant that income from an LLC would flow directly to each member through the partnership conduit conduit /con·du·it/ (kon´doo-it) channel.
ileal conduit the surgical anastomosis of the ureters to one end of a detached segment of ileum, the other end being used to form a stoma on the to then be taxed at their individual rates. This ruling meant that double taxation was avoided by LLC members.
After this ruling, interest in LLCs grew rapidly. Now members could finally be assured of favorable tax treatment to accompany the desired limited liability. Other states then followed Wyoming in enacting LLC statutes, including Florida in 1982 (even before the final favorable ruling), Kansas and Colorado in 1990 and Utah and Virginia in 1991. Today, more then 40 states have LLC legislation.
From the period 1982 to 1988, several other IRS An abbreviation for the Internal Revenue Service, a federal agency charged with the responsibility of administering and enforcing internal revenue laws. rulings occurred that affected LLCs. Prior to 1982, the IRS issued several conflicting Letter Tax Rulings (LTRs) concerning LLCs. These significantly slowed LLC development. Because of significant differences in LTR LTR - Langage Temps-Réel.
(French for "real-time language") A French predecessor to Ada, LTR is Modula-like with a set of special-purpose real-time constructs based on an event model. It was mentioned in the reference below.
["An Overview of Ada", J.G.P. 8106082 and LTR 8304138, additional LLC classification rulings were delayed by the IRS. This delay concerning classification ended with Revenue Ruling 88-76, which held that a Wyoming LLC would be taxed as a partnership. Later, in LTR 8937010, partnership treatment was also given to a Florida LLC.
To be safe, the accounting practitioner should check to be sure that the LLC enabling legislation Noun 1. enabling legislation - legislation that gives appropriate officials the authority to implement or enforce the law
legislation, statute law - law enacted by a legislative body in their state has received a favorable LTR. However, in general, LLCs are being treated by the IRS as partnership conduits for taxation.
Why an LLC For Practitioners?
The root of the LLC advantages can be traced to its limited liability and partnership taxation characteristics. Limited liability is present in LLCs. A review of IRS rulings illustrate that an LLC is taxable as a partnership if it lacks two of the four corporate characteristics set forth in Treasury Regulation 301.7701.2. This regulation adopted the definitive classification test under Morrissey v. Commissioner [296 U.S. 344 (1935)]. The characteristics under this classification test are centralized cen·tral·ize
v. cen·tral·ized, cen·tral·iz·ing, cen·tral·iz·es
1. To draw into or toward a center; consolidate.
2. management, continuity of life, free transferability and limited liability.
Since limited liability and centralized management are so important, LLC agreements (similar to partnership agreements) should be structured to eliminate the two characteristics of continuity of life and free transferability of interest. These eliminations allow the LLC to receive the desired and attainable partnership taxation status.
Typically, continuity of life is avoided by requiring the unanimous consent In parliamentary procedure, unanimous consent, also known as general consent, is a situation in which no one present objects. The chair may state, for instance: "If there is no objection, the motion will be adopted. [pause] Since there is no objection, the motion is adopted. of all remaining members to continue the LLC after the death, withdrawal, retirement, bankruptcy or other event causing removal of a member. Free transferability of interests is avoidable by requiring unanimous consent to transfer actual membership rights in the LLC. Majority consent as opposed to unanimous consent to transfer has not been tested. Centralized management can be vested in the members in proportion to capital contributions.
Arguments that limited partnerships possess adequate characteristics and counter the need for LLCs are not sound. Although limited partners of a limited partnership are not personally liable for partnership debts, the general partner is subject to unlimited liability. The use of C corporations as general partners is cumbersome cum·ber·some
1. Difficult to handle because of weight or bulk. See Synonyms at heavy.
2. Troublesome or onerous.
cum and raises issues of subchapter K.
Moreover, limited partners run the risk of being characterized char·ac·ter·ize
tr.v. character·ized, character·iz·ing, character·iz·es
1. To describe the qualities or peculiarities of: characterized the warden as ruthless.
2. by the IRS as general partners and becoming wholly liable if their participation in management is deemed excessive. Participation in management activities actually strengthens the LLC since the member passive activity rules.
Subchapter S corporations would seem an alternative to LLCs in that they also offer limited liability and pass-through of tax. Yet the LLC has even more advantages. Membership in an LLC is not restricted to 35 owners. LLC members can be C corporations, partnerships, trusts, pension plans, foreign investors, not-for-profit, charitable organizations This article is about charitable organizations. For other uses of the word charity, see Charity.
A charitable organization (also known as a charity) is an organization with charitable purposes only. and another LLC. An LLC is not subject to a one-class-of-stock limitation and may even make disproportionate dis·pro·por·tion·ate
Out of proportion, as in size, shape, or amount.
dispro·por allocations and distributions of income and losses. Also, the ownership of other corporation stock by an LLC is not limited to 80% or less.
Additionally, as a Federally taxable partnership, LLCs do not worry about the section 351 tax-free incorporation requirements and can take advantage of section 754 special basis adjustments for external sales of interest. Likewise, liquidating distributions of LLCs are not taxable. All LLC debt is nonrecourse unless a member accepts personal liability. An LLC possesses real and unique advantages for the accounting practitioner.
Creation of an LLC
The creation of a LLC may occur for any purpose except insurance and banking. Most states have modeled their statute after the existing Uniform Limited Partnership Act and the 1977 Wyoming LLC statute. Usually formation costs of an LLC compare favorably fa·vor·a·ble
1. Advantageous; helpful: favorable winds.
2. Encouraging; propitious: a favorable diagnosis.
3. to C corporation formation and are below limited partnership cost. The costs, including attorney fees and filing fees, are usually $750 to $3,000.
The created LLC is a legal entity distinct from its members. Corporate right to sue, be sued, own, convey, etc. are possessed by the LLC. The two or more original members of the LLC can possess any business form as previously described.
Life for an LLC is not perpetual as with a corporation. At the end of stated length of life, the articles of organization (similar to articles of incorporation The document that must be filed with an appropriate government agency, commonly the office of the Secretary of State, if the owners of a business want it to be given legal recognition as a corporation. for a corporation and the partnership agreement for a partnership) may be amended. Additionally, the old LLC assets may be simply transferred to a sister LLC. However, unless properly structured, the transfer may key a tax event.
The name of the company must in some way designate des·ig·nate
tr.v. des·ig·nat·ed, des·ig·nat·ing, des·ig·nates
1. To indicate or specify; point out.
2. To give a name or title to; characterize.
3. the LLC's status. Florida requires a name ending of "limited company" while Wyoming requires "limited liability company." To be safe, the LLC status should be identified in the name.
The articles of organization must contain:
* purpose (usually broadly defined),
* place of business and registered agent in state,
* initial capital contribution,
* method of admitting new members,
* method of continuation when a membership is withdrawn,
* management procedure, and
* other desired provisions.
Similar to the Uniform Partnership Act, silence in the articles causes default. If silent on management, all members are deemed to share votes according to according to
1. As stated or indicated by; on the authority of: according to historians.
2. In keeping with: according to instructions.
3. their capital accounts. Absent a management procedure, managers cannot bind the LLC to third parties. This would rest only with the members as a group.
Subordinate to the articles of organization are an LLC's regulations. Similar to a corporation's bylaws The rules and regulations enacted by an association or a corporation to provide a framework for its operation and management.
Bylaws may specify the qualifications, rights, and liabilities of membership, and the powers, duties, and grounds for the dissolution of an or a detailed partnership agreement, these regulations should contain provisions for the LLC's operation and management. Because of this, the LLC can allocate items of income, gain or loss, deduction and credit under the "substantial economic effect" of IRS 704(b)(2) and Treasury regulations 1.704-1(b)(2)(ii)(a). These allocations should not create a deficit in the member's capital account, since dissolution Act or process of dissolving; termination; winding up. In this sense it is frequently used in the phrase dissolution of a partnership.
The dissolution of a contract is its Rescission by the parties themselves or by a court that nullifies its binding force and reinstates each with deficits will cause special problems. To maintain limited liability, the articles of organizations should avoid requiring additional member contributions when certain events occur.
Why An LLC?
Most accountants currently operate in sole proprietor proprietor n. the owner of anything, but particularly the owner of a business operated by that individual.
PROPRIETOR. The owner. (q.v.) or partnership form for tax reasons or because states do not permit incorporation to limit professionals' liability. The Companies Act of 1989 removed the ban on accountants' incorporation although care must still be exercised toward contractual limitations. This limitation carried over from 310 of the earlier 1985 Act.
A relatively inexpensive LLC will answer these limitations. Liability can be limited and undesirable double taxation will not occur. Recently, the IRS even sweetened sweet·en
v. sweet·ened, sweet·en·ing, sweet·ens
1. To make sweet or sweeter by adding sugar, honey, saccharin, or another sweet substance.
2. To make more pleasant or agreeable. the LLC environment with LTR 9321047. This allows that professionals (accountants) will be able to retain the cash method of accounting in an LLC. Of course, accrual accounting Accrual Accounting
An accounting method that measures the performance and position of a company by recognizing economic events regardless of when cash transactions happen.
Notes: under Generally Accepted Accounting Principles The standard accounting rules, regulations, and procedures used by companies in maintaining their financial records.
Generally accepted accounting principles (GAAP) provide companies and accountants with a consistent set of guidelines that cover both broad accounting was already LLC-allowed.
The LLC's greatest weakness may be its status in states without LLC legislation. When a LLC organized in a LLC state does business in a non-LLC-recognized state, the limited liability doctrine may vanish. In this non-LLC state, liability for members may exceed the entities' net worth. Because of this, an accounting firm may have to alternatively organize in these states in order to do business with limited liability.
The relatively new form of business named the limited liability company (LLC) is a real alternative to the older forms such as C corporation, S corporation, limited and full partnerships and sole proprietorship. LLCs offer an end to double taxation and provide limited liability. Furthermore, LLCs eliminate the real limits of S corporations and limited partnerships. Accounting practitioners should strongly consider the limited liability company as a viable business form.
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19 Smiley See emoticon.
smiley - emoticon , S, "New Revenue Rulings Analyze Partnership Status of German GmbH Along with Virginia and Colorado Limited Liability Companies." Journal of Partnership Taxation 10 (Fall 1993): 255-262.
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Donald Martin, PhD, is an associate professor of accounting at Central Missouri State University Missouri State University is a state university located in Springfield, Missouri. It is the state's second largest university in student enrollment, second only to the University of Missouri. From 1972 to 2005, Missouri State was known as Southwest Missouri State University. , Warrensburg, Missouri Warrensburg is a city in Johnson County, Missouri, United States. The population was 16,340 at the 2000 census. It is the county seat of Johnson CountyGR6. The Warrensburg Micropolitan Statistical Area consists of Johnson County. .