Limited liability CPA firms: an attractive choice.

Nearly every state has passed legislation allowing businesses the choice of operating as limited liability companies (LLCs) or limited liability partnerships (LLPs). LLCs combine the characteristics of corporations and partnerships, making their a viable tool for CPA firms. LLCs limit members' personal liability exposure like a corporation and, if properly structured, may receive the beneficial federal tax treatment of a partnership.

LLPs generally provide less liability protection to members than LLCs. Innocent partners in LLPs may be protected from personal liability for the negligence and malpractice of other partners, but in the case of ordinary commercial debt, members of an LLP may not be protected. However, it may be easier for a CPA firm to convert to an LLP and gain the added liability protection without a lot of red tape.

For CPA firms, forming either an LLC or an LLP is particularly attractive--in the wake of business failure CPA firms often are the targets of lawsuits. Because there is no single form of practice that will meet the needs of all firms in all states, CPAs choosing an organizational structure should understand the various forms of business entities available. They should know how state laws treat these forms of business entities and know the form that best meets their objectives.

Limited liability companies

LLCs offer limited liability to all firm members and are treated as partnerships, not as corporations, for federal income tax purposes if they do not have more than two of the following corporate characteristics:

* Limited liability protection.

* Free transferability of interests.

* Continuity of life.

* Centralized management.

Becker Rutledge, member of Marcus & Rutledge, LLC, in Metairie, Louisiana--the first CPA firm in Louisiana to become an LLC--was a sole proprietor who, after joining with John Marcus, chose to form an LLC for the ownership flexibility and the limited liability it provides members. "You know yourself, and when you form a business organization with other people you hope you know them, but there are always surprises lurking that make members vulnerable in a general partnership. We chose to form an LLC because each member would be protected against the professional liability of the other members," said Rutledge.

In most states, LLCs are formed by filing an articles of organization with the secretary of state and by paying the requisite filing fee. "It is very inexpensive for us to be an LLC," said Rutledge. "We filled out the form ourselves, and our state fee was $60. Of course, if you want to do anything different from what the state legislation's default provisions provide, you may want an attorney to create your operating agreement."

How safe is an LLC?

As of May 1995, an LLC's risk protection had not been tested. "The state courts have not ruled on whether an LLC is effective in insulating the members from the risks in the business," said Bryan P. Collins, partner of Arthur Andersen & Co. in Washington, D.C. Collins also said in some cases owners of an LLC could be subject to higher individual federal or state tax rates as well as self-employment taxes. "Once you have accepted that an LLC is to be treated as a partnership for tax purposes, it leaves certain tax questions unresolved on how partnership rules are applied to LLCs."

Limited liability partnerships

For many CPA firms, especially firms already practicing as general partnerships, converting to an LLP is the easiest solution. To register, CPA firms hive only to file a registration form with the state. Also, because an LLP is merely the continuation of an existing partnership, it is not necessary to modify the existing partnership agreement. Some states impose minimum insurance requirements for professionals practicing in LLPs, and some states impose an entity-level tax on LLPs in addition to taxing the individual partners.

Plante & Moran, LLP, a CPA firm in Southfield, Michigan, with over 100 partners, did not want to go through a massive restructuring to convert from a general partnership to an LLC. "When Michigan passed LLC legislation everybody thought it was a panacea," said partner N. Patricia Kurtz. "But in order to be aD LLC in Michigan, all partners had to be licensed ill the profession of the firm. In our case everyone would have to be a CPA, and we had a number of partners who were not CPAs. The LLP provided us with the best alternative. We simply had to register with the state that we were converting to an LLP. Also, because we were a general partnership before the conversion, there were no tax consequences. It was an inexpensive way to give us the limited liability protection that did not have before." Kurtz said the largest cost of conversion was adimistrative. "We had to change the firm's name. This meant that we had to change our letterheads, reports, engagement letters and business cards."

Know what your state offers

Not all states have LLC legislation beneficial to CPAs. California and Rhode Island have passed LLC legislation but specifically limit professions from taking advantage of an LLC's benefits. Janice Vincent, partner of Ernst & Young, LLP, in Los Angeles, said her firm was able to form an LLP after the California state board ruled that an LLP was, in substance, a general partnership. "The state board said that we could practice in LLP form, but because LLP legislation is still pending in California, we would not have the protection of limited liability. The only benefit of forming an LLP is our ability to be in the same partnership as our partners in New York, Texas and Florida. We are missing out on the safety net for innocent partners."

In Texas, the legislature amended its laws to allow CPA firms to choose to operate as LLCs or LLPs. One midsized firm in San Antonio took advantage of both forms of practice. Botell, Matthys & Polansky, LLP, is a five-partner CPA firm that organized two LLCs into an LLP. One LLC is composed of the principal partners, while the other is composed of associate partners. Together the LLCs make up the LLP.

"This is a lot like a parent company owning a subsidiary," said Edward M. Polansky. "We feel this gives us the best liability protection." Even so, Polansky said the firm continues to hold liability insurance.

Polansky said that one drawback to this type of organization was the complex recordkeeping involved.

"There are separate tax returns for each of the entities that flow through income and expenses," said Polansky. He also said this style of organization has been expensive, because each of the three entities had to be separately registered, and LLCs in Texas are subject to a franchise tax like a corporation. However, Polansky said the added protection was worth the extra cost and trouble.

Helping clients choose the right form of practice

Choosing to organize as an LLC or LLP can be just as advantageous to a CPA's clients as it is to a firm. "CPAs need to consider three basic issues when advising clients on choosing a new form of practice," said Arthur Andersen's Collins.

* Business risks. LLCs and LLPs are relatively new and it remains to be seen how safe these businesses really are.

* Tax implications. State and federal tax treatments may vary. CPAs need to know all the options--from the higher individual rates versus the lower corporate rates to self-employment taxes.

* Operations. CPAs need to know the client's management structure to ensure that forming either an LLP or an LLC will best fit its operational objectives.

The AICPA and form of practice

The American Institute of CPAs and the National Association of State Boards of Accountancy Uniform Accountancy Act and Uniform Accountancy Act Rules has been revised to provide for additional forms of practice for accounting firms. The AICPA offers assistance to state societies and to members concerning forms of practice. For more information on the status of limited liability legislation in your state contact your state society or the AICPA state legislation division at [phone].

RELATED ARTICLE: AcSEC ISsues Guidance on Accounting and Reporting

for LLCs and LLPs

The American Institute of CPAs accounting standards executive committee (AcSEC) has issued guidance on accounting and reporting for limited liability companies (LLCs) and limited liability partnerships (LLPs). Practice Bulletin 14, Accouting and Reporting by Limited Liability Companies and Limited Liability Partnerships, supports a partnership-based financial statement presentation and provides guidance on applying existing authoritative literature related to the formation of LLCs and LLPs. Accounting issues not covered in the practice bulletin should comply with existing requirements of generally accepted accounting principles.

"There were a lot of CPAs who wanted to know how financial statements for LLCs and LLPs should appear," said Michael Crooch, partner of Arthur Andersen & Co. in Chicago and chair of AcSEC. "This practice bulletin will improve disclosure and make the process of providing financial statements for LLPs and LLCs more efficient for our members."

The practice bulletin went into effect May 15, 1995.