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Conducting Business as a Limited Liability Company

There's no one legal structure that works best for all businesses. The most favorable choice depends on a number of factors, including the number of owners, your tax situation, and whether or not you have employees. A limited liability company (LLC) may be a good choice because it provides flexibility, low maintenance, favorable tax treatment, and most importantly, limited liability protection to keep your personal assets safe.

Dodging a Double Tax Hit

An LLC can help avoid double taxation if you sell the company or some of its assets. Let's say your company spends $10,000 to buy a warehouse and later sells it for $110,000, making a profit of $100,000.

As a C corporation: You're liable for a combined federal and state tax bite of as much as 40 percent, trimming your gain to $60,000. Now you can take the gain as salary or a dividend distribution. If you take the money as a dividend, your company loses a deduction and you pay personal taxes on the cash. In the highest bracket, that's 45 percent. Add the $27,000 tax bill to the total and you and the company have paid $67,000 in combined taxes. If you take the money as salary, your company keeps its deduction, but now payroll taxes kick in.

As an LLC: The IRS taxes you only on your personal return and at low capital gains rates. So your tax liability is likely to be $25,000. And you're hit only one time.

A properly-organized LLC combines some of the aspects of partnerships and corporations into one entity. For example, partnerships and sole proprietorships generally have no insulation from liability. But a member of an LLC has limited liability and no personal responsibility for the debts or liabilities of the entity or the other members.

LLCs can work well for family businesses that have exposure to liabilities, real estate enterprises, and service companies. You need to discuss the specific benefits of various business structures with your attorney. Here is a list of general LLC issues to consider:

Federal and State Taxes

LLCs avoid double taxation. Like an S corp or a partnership, an LLC is a tax "pass-through" entity - it files a federal tax return, but distributes some of the pre-tax profits, or losses, to its members, who then pay tax on their personal returns. Under a C corporation structure, the company pays taxes on its earnings and then you also pay on your income.

Employment Taxes

LLCs, like S corps and partnerships, distribute income to their members and the money isn't considered wages by the IRS so there are no employment taxes. However, a member who is active in the business has to pay self-employment taxes. Of course, you must pay employment taxes for your employees.

Formation

It's fairly easy to form an LLC. Your attorney should file Articles of Organization with the state and create an operating agreement among the members. The operating agreement establishes members' rights, the percentage of ownership and the share of profits. Owners can include corporations, partnerships, other LLCs or trusts. An operating agreement should also contain provisions for the company's management structure and any other financial details you want, such as ways to use the LLC in estate planning.

Management

In nearly every state, you can form an LLC with just one person but there's no limit on the number of members you can have. In theory, all members can participate in managing the company. But smooth operations normally depend on a centralized management to ensure good communication and the ability to reach consensus. In your operating agreement, you can designate one or more owners to take on daily management responsibilities.

Limited Liability

LLC members aren't personally liable for the company's debts. However, this is not blanket protection. The corporate veil may be pierced if there is malpractice. Members may still be liable for debts if they personally guarantee them. And they're liable if they don't deposit taxes withheld from employees' wages or use the company to conduct personal business. Beyond that, members are liable only up to the amount of their capital contributions and the amount they agree to contribute to the firm's capital.

Estate Planning

An LLC can replace a family limited partnership as an estate-planning tool. An operating agreement can include features that let you make gifts of equity while maintaining control of the LLC. You can also reduce the value of the gift. When you give a minority, non-voting stake in the company it isn't valued at face value, but can be discounted by as much as 35 percent. One way to get IRS discounts is to set the company up so that senior members retain control but give minority interests over time at greatly reduced rates. The beneficiaries don't gain control until very late in the process.

An LLC's tax advantages, combined with insulation from liability and estate-planning benefits, can make it a suitable and cost-effective alternative to other business entities.

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