A CPA friend of mine recently sent me a list about LLCs that he had sent out in a newsletter. I let him know that his source for newsletter information doesn’t understand a fundamental basic concept of LLCs–that the LLC tax structure and legal structure are totally separate from each other. Check out his list and my comments with links to additional explanations:
Ten Things You May Not Know About an LLC
You probably know of several businesses whose formal names end with the acronym LLC. And you probably also know that LLC stands for limited liability company. Here are ten things you may not know.
- An LLC generally protects its owners from personal liability for business obligations in much the same way a corporation does, but an LLC is not a corporate entity. The corporate shield is identical to a corporation. The LLC has a second type of asset protection called charging order protection that a corporation does not have. This aspect of an LLC was derived from partnership law.
- Like a corporation, an LLC can do business in multiple states, although an LLC must be organized in a specific state. It also has to register in each state where it does business.
- The owners of an LLC are called “members.” There is no limit on the number of members an LLC can have. This is not true. The number of members is dictated by the tax selection that is made for the LLC. If a Subchapter S election is made, the rules of Subchapter S or the IRS code govern, and there is a limit on the number of members. Members don’t necessarily have to be individuals. If there is a Subchapter S election, the members have to be resident aliens or US citizens. Members’ management roles are typically spelled out in an operating agreement. Yes, they are usually spelled out in the operating agreement. Note that the operating agreement should also spell out whether the LLC is designated as a member managed or a manager managed LLC.
- Upon formation of an LLC, the members contribute cash, property, or services to the LLC in exchange for LLC shares or units. The ownership currency of an LLC is known as membership interests, not shares or units.
- An LLC may borrow money in its own name and is responsible for repayment of the debt. I will guarantee that in a closely held LLC, the owner will sign personally on any mortgage or loan. The implication that the LLC will be responsible solely for the debt is a dream.
- An LLC is usually treated as a partnership for federal income-tax purposes. I have no idea what percentage of LLCs are taxed under partnership rules. I would assume the most common LLC is a sole proprietorship taxation structure, although there are many Subchapter S tax structures and even some Chapter C tax structures used by LLCs. Note that his remaining four points assume partnership treatment.
- Like partners, LLC members are not considered employees of the company. However, an LLC can have non-member employees.
- LLC members are taxed directly on company income. The LLC itself doesn’t pay federal income taxes.
- If an LLC has a loss, its members generally can deduct their share of the loss on their own tax returns.
- For tax purposes, an LLC’s income and losses are divided among its members according to the terms of their agreement. Tax allocations must correspond to economic allocations of profit and loss.