Limited Liability Companies
An LLC is a non-corporate business that provides its members with limited liability, a single tax, and the option to participate actively in the entity’s management.
Note: Members or designated managers are not personally liable for company debts in a limited liability company.
The Code does not recognize an LLC as a distinct entity. Thus, an LLC could be treated for tax purposes as:
(1) A partnership,
(2) An association taxable as a corporation, or
(3) A trust.
Although an LLC exhibits the corporate characteristic of limited liability, the entity usually is treated as a partnership for federal income tax purposes because it could be organized without continuity of life, centralized management, or free transferability of interests.
LLC Benefits
When a limited liability company is a partnership for tax purposes, it can provide several benefits:
(1) Pass-through of tax attributes under the partnership tax rules;
(2) Limited liability to all members;
(3) Control over the business by the members without the risk that management participation will cost members their limited liability; and
(4) Freedom from S corporation eligibility requirements.
Advantages of LLCs over C Corporation
Double Tax
C Corporations pay federal and state income tax as a separate entity. The distributed income of a C corporation may be taxed twice, as the shareholder is also taxed on dividends received from the C corporation. Perhaps the biggest benefit of the LLC over the C corporation is that the LLC is subject to one level of tax that is paid by the members of the LLC.
Note: C corporations also may be subject to an accumulated earnings tax or a personal holding company tax. These taxes are not imposed on an LLC.
Basis Adjustment
A C corporation cannot adjust the tax basis of its assets in connection with a transfer of its shares. If the LLC makes a §754 election, the LLC can adjust the tax basis of its assets in connection with transfers of membership interests. If the LLC is holding assets with a fair market value in excess of basis, the availability of such an adjustment may be valuable and may help the transferring member to obtain a higher price for his interest.
Special Allocations
A C corporation may not specially allocate income or loss to its shareholders. An LLC, because it is treated as a partnership for income tax purposes, may specially allocate income or loss within the provisions of §704(b).
Contributions
Corporations cannot receive tax-free contributions of property unless, immediately after the contribution, the contributor (alone or with others making contributions in related transactions) holds at least 80% of the total combined voting power of all classes of stock entitled to vote and at least 80% of the total number of shares of all other classes of stock of the corporation. LLCs generally can receive tax-free contributions of property from any member.
Liquidation
A C corporation is subject to a double tax on liquidation. An LLC generally can be liquidated without triggering any adverse tax consequences to the members.
Advantages of LLCs over S Corporations
S corporations operate under many restrictions that do not apply to LLCs. These restrictions include the following:
(1) S corporations are limited to 100 shareholders;
Note: There are no restrictions on who may be a member of an LLC or on the number of members.
(2) S corporations are limited to a single class of stock;
Note: LLCs can have multiple classes of stock outstanding and an infinite variety of interests.
(3) S corporations cannot have a shareholder that is a corporation, partnership, LLC or unincorporated entity other than a qualified estate or trust;
Note: LLCs can have any form of entity as a member. This flexibility will provide a significant advantage to C corporations that otherwise may benefit from any losses reported by subsidiaries only through filing a consolidated return.
(4) S corporation cannot have a shareholder who is a nonresident alien individual;
Note: LLCs can have nonresident alien members.
(5) S corporation shareholders cannot include indebtedness of the S corporation in basis;
Note: The tax basis of an LLC membership interest includes the member’s share of the entity’s indebtedness, which may shelter from current gain recognition any operating distributions of cash.
(6) S corporation cannot make an §754 election to increase the tax basis of its assets in connection with a transfer of its shares; and
Note: On the death of a shareholder or sale of stock an LLC can elect to adjust the basis of its assets.
(7) Some states do not fully recognize S corporations. For example, S corporations that are doing business in California must pay a 1.5% net income tax.
Note: LLCs are not subject to this tax, but they must pay an entity level fee based on gross receipts. If the business operates at a loss, the S corporation form generally is preferable. If the entity operates at a profit, then the LLC generally will result in the lesser tax liability.
An LLC is a non-corporate business that provides its members with limited liability, a single tax, and the option to participate actively in the entity’s management.
Note: Members or designated managers are not personally liable for company debts in a limited liability company.
The Code does not recognize an LLC as a distinct entity. Thus, an LLC could be treated for tax purposes as:
(1) A partnership,
(2) An association taxable as a corporation, or
(3) A trust.
Although an LLC exhibits the corporate characteristic of limited liability, the entity usually is treated as a partnership for federal income tax purposes because it could be organized without continuity of life, centralized management, or free transferability of interests.
LLC Benefits
When a limited liability company is a partnership for tax purposes, it can provide several benefits:
(1) Pass-through of tax attributes under the partnership tax rules;
(2) Limited liability to all members;
(3) Control over the business by the members without the risk that management participation will cost members their limited liability; and
(4) Freedom from S corporation eligibility requirements.
Advantages of LLCs over C Corporation
Double Tax
C Corporations pay federal and state income tax as a separate entity. The distributed income of a C corporation may be taxed twice, as the shareholder is also taxed on dividends received from the C corporation. Perhaps the biggest benefit of the LLC over the C corporation is that the LLC is subject to one level of tax that is paid by the members of the LLC.
Note: C corporations also may be subject to an accumulated earnings tax or a personal holding company tax. These taxes are not imposed on an LLC.
Basis Adjustment
A C corporation cannot adjust the tax basis of its assets in connection with a transfer of its shares. If the LLC makes a §754 election, the LLC can adjust the tax basis of its assets in connection with transfers of membership interests. If the LLC is holding assets with a fair market value in excess of basis, the availability of such an adjustment may be valuable and may help the transferring member to obtain a higher price for his interest.
Special Allocations
A C corporation may not specially allocate income or loss to its shareholders. An LLC, because it is treated as a partnership for income tax purposes, may specially allocate income or loss within the provisions of §704(b).
Contributions
Corporations cannot receive tax-free contributions of property unless, immediately after the contribution, the contributor (alone or with others making contributions in related transactions) holds at least 80% of the total combined voting power of all classes of stock entitled to vote and at least 80% of the total number of shares of all other classes of stock of the corporation. LLCs generally can receive tax-free contributions of property from any member.
Liquidation
A C corporation is subject to a double tax on liquidation. An LLC generally can be liquidated without triggering any adverse tax consequences to the members.
Advantages of LLCs over S Corporations
S corporations operate under many restrictions that do not apply to LLCs. These restrictions include the following:
(1) S corporations are limited to 100 shareholders;
Note: There are no restrictions on who may be a member of an LLC or on the number of members.
(2) S corporations are limited to a single class of stock;
Note: LLCs can have multiple classes of stock outstanding and an infinite variety of interests.
(3) S corporations cannot have a shareholder that is a corporation, partnership, LLC or unincorporated entity other than a qualified estate or trust;
Note: LLCs can have any form of entity as a member. This flexibility will provide a significant advantage to C corporations that otherwise may benefit from any losses reported by subsidiaries only through filing a consolidated return.
(4) S corporation cannot have a shareholder who is a nonresident alien individual;
Note: LLCs can have nonresident alien members.
(5) S corporation shareholders cannot include indebtedness of the S corporation in basis;
Note: The tax basis of an LLC membership interest includes the member’s share of the entity’s indebtedness, which may shelter from current gain recognition any operating distributions of cash.
(6) S corporation cannot make an §754 election to increase the tax basis of its assets in connection with a transfer of its shares; and
Note: On the death of a shareholder or sale of stock an LLC can elect to adjust the basis of its assets.
(7) Some states do not fully recognize S corporations. For example, S corporations that are doing business in California must pay a 1.5% net income tax.
Note: LLCs are not subject to this tax, but they must pay an entity level fee based on gross receipts. If the business operates at a loss, the S corporation form generally is preferable. If the entity operates at a profit, then the LLC generally will result in the lesser tax liability.