The limited liability company (LLC) is one of the newest forms of doing business in the United States. The LLC combines the limited liability of a corporation with the pass through taxation of a partnership. LLC's are great tools for small operating businesses and for businesses whose sole purpose is to hold real estate. While LLC's don't provide many of the same fringe benefits as a C-corporation the flexibility and the simplicity of ownership make it the ideal tool for a small company.

``HOW DO I DECIDE HOW TO MANAGE MY LLC? ``

Your LLC can either be managed by the members of the LLC or your LLC can decide to use an outside manager, it really depends upon the long term goals of the LLC. For instance, if there are passive investors that will have no part in the management of the company, then it would probably be best for the LLC to be manager managed. However, if the LLC is going to be a way for a family to invest together, it might be best to have the LLC managed by the members.

As you are making the decision about the management of the company, keep in mind there could be some tax benefits to your decision. For example, if you create a corporation, and it serves as the manager of the LLC, you may be able to receive additional tax benefits such as being able to write off 100% of your allowable medical expenses!

``HOW IS MY LLC TAXED?``

LLC's offer flexibility in the way they are taxed. LLC's can choose to be taxed as sole proprietorship, partnership or as a corporation. (Note: yes, they can elect to even be taxed as a S corporation.)

By default, the IRS taxes an LLC a couple of different ways. When there is only one member in the LLC, by default the LLC will be taxed as a disregarded entity, which means all the profits and losses will pass through to the member's income tax return. When there is more than one member in an LLC, by default the LLC will be taxed as a partnership, which means all the profits and losses will pass through to the member's income tax return, therefore the LLC will not pay taxes as a business entity.

If you wish to have the LLC taxed as a corporation, then you will have to file a form 8832 with the IRS within 75 days of receiving the Employer Identification Number for the LLC.

``DO ALL PROFITS AND LOSSES IN MY LLC GET DIVIDED EVENLY?``

Another benefit to having an LLC is the flexibility in distributing profits and losses to the members. Distributions of the LLC can be based on the total amount or percentage of membership interest each party has, it can be based on the amount of work they put into the company, or a number of other flexible distribution formulas.

Example:
If you started a computer programming business with a partner and you contributed all the capital and your partner was the brains behind the programming but didn't have any money, you might decide to allocate a greater percentage of the distribution to you for a few years until you receive some of your investment back and then reevaluate the situation.

``WHY SHOULD I USE AN LLC?``

The big benefit of using a LLC is that you receive limited liability protection on the activities within the LLC, and yet at the same time, the tax effects flow through the LLC down to your personal return. Compare that with a corporation. While the corporation does provide for limited liability, the tax effects of buying and selling real estate can be horrendous.

Example: Let's say you want to buy some rental property but, you know how risky it is to have tenants. So you decide to form an LLC and have the LLC buy the property. As a general rule, the owner of the property, the LLC is liable for liability generated from the property itself. This can help protect you if the LLC were ever sued.

Example: A small group of family, friends or business associates decide to start a small consulting firm. Instead of forming a partnership which adds risk to everyone involved you decide to form an LLC. This provides limited liability to the members. In addition, some people are buying ownership with cash while others are going to be providing their services. Since you can adjust the distribution in the operating agreement, the people who contribute cash are going to get there desired percentage of distributions.

Example: You already own a corporation but you want to buy some property personally that the company might be using in the future. So you form an LLC and have the LLC purchase the property. In a few months the corporation decides it needs that property to expand, so the corporation leases the property from the LLC. This allows you to sell the property in the future without being subject to the double taxation of a C-Corporation.

Converting your current sole proprietorship or a partnership to an LLC is relatively easy. In many cases it's simply a matter of forming the LLC and re-titling the assets of your business in exchange for the ownership of the LLC. In some states you might have to publish a notice in a newspaper, but that is pretty much it. Not only that, if you do things right, it can probably be done as a non taxable event.

``WHAT ARE THE DISADVANTAGES TO THE LLC?``

The biggest problem with the LLC is that they are so new. First recognized by Wyoming in 1976, other states never even allowed LLC's until 1991. Only until 1997 did all states finally recognize the LLC. Because of this, there is limited case law for LLCs, however, as time goes on more and more cases are coming out, thus adding certainty to the actions of the LLC.

In addition, tax treatment is not entirely carved in stone, and the IRS and certain states have from time to time made changes that could be adverse to people in particular situations. For instance, in Texas an LLC is taxed as a corporation no matter if the IRS views you as a partnership or not. In California, an LLC is required to pay an annual $800 franchise tax.

Not all businesses can operate as an LLC. Businesses in the banking, trust and the insurance industry, for example, are typically prohibited from forming an LLC. Some states have their own restrictions on who can form an LLC. In California, architects, accountants, lawyers, doctors and other licensed professionals are prohibited from using an LLC to operate their business. (California is of the belief that all professional services should be done under a professional corporation.)

*Please note that the requirements for filing can differ greatly from state to state.

``HOW DO I KNOW IF AN LLC IS RIGHT FOR ME?``

1. You are in a high risk business, or are concerned about liability; or
2. You are not a citizen or permanent resident of the United States; or
3. You want full control to decide which members get what amount of any losses or gain each year to pass through to them; or
4. You want to control how your company is treated for tax purposes.

However, there are still important differences between C Corporations, S Corporations and LLC's.

Advantages:
Fewer corporate formalities. Corporations must hold regular meetings of the board of directors and shareholders, keep written corporate minutes and file annual reports with the state. On the other hand, the members and managers of an LLC need not hold regular meetings, which reduce complications and paperwork but they should hold at least one meeting a year.

No ownership restrictions. S-corporations cannot have more than 100 stockholders, and each stockholder generally needs to be a natural person who is a resident or citizen of the United States. There are no such restrictions placed on an LLC.

Ability to use the cash method of accounting. Unlike a C-corporation, which often must use the accrual method of accounting, most limited liability companies can use the cash method of accounting. This means that income is not taxable until it is received.

Ability to deduct losses. Members who are active participants in the business of an LLC are able to deduct its operating losses against the member's regular income to the extent permitted by law. Shareholders of a corporations have limitations on how much, if any of the business losses are allowed to be deducted on their personal tax return.

Unemployment tax. In many cases, a member-employee of an LLC is not required to pay unemployment insurance taxes on his or her salary. Shareholder-employees of corporations must pay this tax. Currently, the federal unemployment tax is 6.2% of the first $7,000 of wages paid, to a maximum of $434 per employee.

Disadvantages:
Profits subject to social security and Medicare taxes. In some circumstances, owner-employees of an LLC may end up paying more taxes than owner-employees of a corporation. Salaries and profits of many LLCÕs are subject to self-employment taxes, currently equal to a combined 15.3%. With a corporation, only salaries (and not profits) are subject to such taxes. This disadvantage is most significant for member-employees who take a salary of less than $97,000.

For example, if a member earns $40,000 in salary and is distributed $20,000 of the LLC's profits, a 15.3% tax would have to be paid on $60,000. For an S-corporation, social security and Medicare taxes would only have to be paid on the $40,000 salary, so long as it was a reasonable amount. Keep in mind, however, that the IRS frowns upon employee-owners of an S- corporation not paying themselves a reasonable salary and simply distributing the profits. In situations where the IRS feels that shareholders are taking too little in salary, the IRS will re-characterize all or part of the profits as salary.

LLC's may also elect to be treated and taxed as an S-Corporation if needed. This would help lower the social security and Medicare taxes. This type of election should be made if the income generated by the LLC will be considered earned income, not passive. (Passive income is limited to 25% of income produced by a company when being taxed as an S-Corporation.)

Another downside is that owners must immediately pay taxes on their profits. A C-corporation does not have to immediately distribute its profits to its shareholders as a dividend. This means that shareholders in a C-corporation are not always taxed on the corporation's profits. Because an LLC is not subject to double-taxation, the profits of the LLC are automatically included in a member's income. To find out which is best in your situation, you should run the numbers to make sure you are getting al the benefits you are entitled to.

Fewer fringe benefits. Member-employees of an LLC who receive fringe benefits, such as group insurance, medical reimbursement plans, medical insurance and parking, must treat these benefits as taxable income. The same is true for stockholder-employees who own more than 2% of an S-corporation. However, stockholder-employees of a C-corporation who receive fringe benefits do not have to report these benefits as taxable income.