Limited Liability Companies are the vehicle of choice for small business owners and private companies. Why choose anything else? LLCs have many advantages, including the top four:
- ease of operating and flexibility in managing.
- flexibility for profit sharing;
- limited liability for members; and
- flexibility for tax planning.
Ease and Flexibility in Operating and Managing LLCs
LLCs can have a single member or multiple members. They can be managed by all members or only a single member. The managing member may be the sole owner, have a small ownership interest or even no equity interest at all. In contrast to limited partnerships, there is no need for a general partner that has unlimited liability. Compared to corporations, there is no need to draft corporate bylaws, appoint a board of directors and organize regular board meetings, or to hold an annual shareholders meeting. LLCs work well for sole proprietorships, newly established ventures, as well as for large, complex companies, partnerships and joint ventures alike.
Flexibility for Profit Sharing
LLCs provide great flexibility in sharing and dividing profits. LLCs can issue different classes of units that entitle holders to different priorities, which facilitates sharing profits between “money” investors and employees or service-providers that provide sweat equity. These profit sharing provisions can be as complex or as simple as the members desire.
The title speaks for itself: assuming members do not make personal guarantees, LLCs generally provide their members with limited liability. Of course, distributions cannot be made that threaten the solvency of the LLC. If members make distributions that cause insolvency, they risk voiding the limited liability of the LLC, which may allow creditors to make claims against the members.
As a tax lawyer, the feature I appreciate the most for LLCs is tax flexibility. By default, LLCs are taxed as pass-throughs. This means that the LLC does not itself pay any tax and instead the income passes through to the LLC’s members.
Although pass-throughs provide many tax advantages, the owners of an LLC may be able to lower their tax liability using a different type of entity such as an S-Corporation or even a C-Corporation. However, even if the owners see a tax advantage in an S-Corp or C-Corp, there is no need to use a different type of entity because an LLC can elect to be taxed as an S-Corp or a C-Corp. Business owners who want their business to be taxed as a C-Corporation can form an LLC to take advantage of the flexibility of operating an LLC while being taxed like a corporation.
Determining the optimal type of entity can be a complex exercise and you should consult your tax advisor. It is always better to get tax advice before doing something that may be difficult, expensive, or impossible to undo. If you are unsure, call me for a free consultation to decide if you need tax advice.