Kyle's Blog

Limited Liability Company - LLC

Kentucky law recognizes businesses operating as limited liability companies (LLCs). The LLC is the newest form of a business organization. It is a hybrid of a corporation and a limited partnership that is created under state law. The LLC features pass through taxation of the partnership, and limited liability of the corporation. An LLC is a partnership that offers the limited liability protection of a corporation. Or conversely, it’s a corporation that’s taxed like a partnership. It is much like an S corporation without the 75 shareholder limitation.

The LLC is a promising type of business entity, but it does have a few disadvantages. The newness means that law regarding the LLC is still evolving and some issues regarding its operation remain unsettled. If the LLC is taxed as a partnership, business owners will lose some company funded benefits.

LLCs follow the federal rules on how they will be taxed. Accordingly, if your LLC is treated as a partnership, it will not be taxed on its net income. Instead, members must include in their < prefix = st1 />Kentucky taxable adjusted gross income their distributive share of LLC income. If a business is classified as an association taxable as a corporation for federal income tax purposes, it will also be taxable as a corporation for Kentucky tax purposes. For federal tax purposes, an LLC is treated identically to a partnership and it must file a Form 1065, U.S. Partnership Return of Income. (There is an exception to this rule for single-owner LLCs, which are treated identically to sole proprietorships and whose owners must simply file a Schedule C with their Form 1040.) Under state laws, LLC owners are given the protection from liability that was previously afforded only to corporate stockholders. As of 1997, all LLCs are treated as partnerships for federal tax purposes; the same is not always true for state tax purposes. You'll need to check your state tax laws. While S corporations also provide limited liability for their owners and favorable pass-through tax treatment, LLCs do provide some additional advantages to growing businesses. Like a partnership, an LLC has the ability to make disproportionate distributions to its owners (for example, a LLC member may have a 50 percent ownership interest in LLC assets but be entitled to 60 percent of the income, if the operating agreement so provides). In contrast, S corporations must generally make all distributions pro-rata in accordance with the number of shares held by each owner. An LLC can have an unlimited number of investors, whereas an S corporation is limited to 75 shareholders.

Typically, the LLC's advantages over the corporation include: Lower state formation and renewal fees
Less complex and burdensome operating rules
Simplified taxation
Better asset protection for the owner's business interest against the claims of personal creditors, because of the Revised Uniform Limited
Partnership Act (RULPA) lineage of the charging order concept applied in many states
Better protection for the owner's personal assets outside the business, as the doctrine of piercing the veil of limited liability is less likely to be applied to the LLC due to its simplified operating rules
Better integration with other planning techniques, including domestic asset protection trusts and estate planning strategies, such as the family limited liability company

The corporation may have an edge over the LLC in three limited situations:
When the small business owner intends to make a public offering of securities that is broad-based (e.g., an Internet offering), a corporation may be more appropriate than an LLC. While the same objective can be accomplished with an LLC, the investing public is more accustomed to purchasing common stock in a corporation, and state securities regulators are more familiar with an offering of common stock. In future years, this may not be the case.
It is possible, although not likely in most cases, that the corporate form would result in lower self-employment taxes than the LLC. Currently, the regular C Corporation can provide a greater amount and more kinds of fringe benefits, tax-free, to its owners, as compared to an LLC. However, small business owners operating a corporation generally will elect subchapter S corporation status. This election will mean that the business will enjoy no fringe benefit advantage over the LLC. Further, the most important fringe benefit, tax-free health insurance, is currently being phased-in for LLC owners (and all self-employed individuals) by federal law. Finally, the LLC can simply elect to be taxed as a C corporation and enjoy the same tax-free fringe benefits advantage, although the benefits derived from such an election will almost never outweigh the disadvantages associated with being taxed as a C corporation.