Frequently Asked Questions Regarding Limited Liability Company(LLCs)
What is an LLC?
LLCs (Limited Liability Companies) are a relatively new business form in the United States , though they have a long-standing history in Europe . LLCs were first formed in the United States in 1977, and were granted pass-through tax status by the Internal Revenue Service in 1988. As a result, LLCs can elect to be taxed like partnerships, with tax incurred only at the individual level when profits are paid as dividends.
Can any person or entity own an interest in an LLC?
Yes. Generally, any legally recognized "person" may own an interest in an LLC except a professional LLC where ownership rules are restricted to licensed practitioners. The question is then what is the definition of a "person"? The definition includes, any may be slightly different from state to state, individuals, partnerships, domestic or foreign corporations, trusts, business trusts, real estate investment trusts, estates, and other associations or business entities. It is common to see a single member LLC owned by an LLC taxed as a partnership or an LLC taxed as a partnership operating a business to be owned by another LLC taxed as a partnership. Consult with your legal professional for guidance in this area.
What are the tax consequences to the members upon the formation of an LLC?
Generally, a person does not recognize gain or loss on property or cash contributed to an LLC in exchange for an interest in the LLC [IRC § 721]. The member's basis in the LLC interest is equal to the amount of the cash and the member's adjusted tax basis in the property contributed [IRC § 722]. Keep in mind it is possible for a member to recognize a gain on the contribution of appreciated property to an LLC. Speak to your tax advisor is this applies in your situation.
What are the advantages of forming an LLC?
Some advantages of forming an LLC are:
- Limitation of Liability: Similar to corporations, LLCs shield personal assets from business debt. LLC members typically will not be liable for the debts and obligations of the LLC because, in most cases, the LLC is viewed as a separate entity in the eyes of the law.
- Tax Advantages: LLCs have "pass-through" tax status, which avoids the double-taxation issues of C corporations. C corporations are separately taxable entities. A C corporation must pay taxes on its income and individuals must pay taxes on the dividends they receive from the corporation. This can lead to double taxation on dividends that are paid out of corporate profits to the owners. Members of LLCs report the LLC's profits and losses directly on their tax returns, therefore they are only taxed once.
- Subsidiaries Allowed. LLCs are allowed to have subsidiaries without restriction.
- Management Similar to Partnership: The management structure of an LLC is much like that of a partnership. This allows the managing members to decide how the LLC will be run and to enter into an agreement formalizing this decision. Members can also appoint "managers" to run the LLC.
How many people are needed to form an LLC?
You can be the sole owner of your LLC in all states except Massachusetts , which requires two people for LLC formation.
What is the ownership structure of an LLC?
An LLC's owners are called "members." A member's interest in an LLC is represented by interest certificates. An LLC is managed by its members, with each having control commensurate to their percentage of ownership, unless the members hire managers to operate the business. If the members hire managers to operate the business, the members can dictate the amount of control the managers will have.
What are the differences between an LLC and an S corporation?
Some differences between LLCs and S corporations are:
- "Memberships" v. Stock Issuance: LLCs cannot issue stock, but rather, they offer "memberships." S corporations, on the other hand, can issue stock and are owned by the shareholders.
- Management: S corporations are managed by the directors and officers, while LLCs are managed directly by the members unless they hire managers.
- Restrictions: S corporations have some restrictions which are not applied to LLCs. For example, S corporations are limited to 100 shareholders, while the number of members in an LLC is not subject to any restriction.
- Taxation: S corporations shareholders potentially will save self-employment taxes (15.3%) on distributions whereas with an LLC taxed as a partnership generally the distributions are subject to self-employment taxes (exception is for passive members).
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