LLC (Limited Liability Company) – FAQS
Clients often come in and talk about their business. I often tell them they should either start and LLC (Limited Liability Company) or convert their S-Corporation into a LLC. That brings up the question, “What is an LLC?” LLCs are statutory. They are formed by filing official documents with the Arkansas Secretary of State’s Business and Commercial Services Office. To start a sole proprietorship or a partnership, you don’t need to file anything. To start a LLC, you do. LLCs have extraordinary legal and tax flexibility and have rapidly become the entities of choice for business start-ups in Arkansas, and many non-LLC entities are converting to LLCs.
Q: How do LLCs Limit Liability?
Like corporations, a Limited Liability Company can provide their owners—called “members”—with a strong statutory liability shield that protects their personal assets from claims against their business. Indeed, the LLC shield is arguably stronger than the corporate shield. This is because, unlike the corporate shield, the LLC shield is immune to the classic corporate “veil-piercing” argument of “failure to comply with statutory formalities.” In Arkansas, LLCs are not subject to the same statutory formalities as corporations.
However, clients must understand that no statutory liability shield—corporate, LLC or otherwise—can protect them from liability for their own negligence or misconduct in conducting their business. Business liability insurance is still a necessity.
Q: What is the Management structure of a LLC?
The default management structure of limited liability company is much simpler than that of corporations. The management structure of single-member LLCs is essentially the same as that of sole proprietorships. Although a corporate structure is available, most multi-member LLCs use a general or limited partnership management structure.
Asset protection. Multi-member LLCs provide their members with powerful statutory asset protections known as “pick-your-partner” and “charging order” protections. These protections are available to corporations only through complex provisions in shareholder agreements.
Statutory flexibility. Compared to corporate statutes, LLC statutes provide business owners with more flexibility to tailor the legal structure of their business to meet owner needs and interests. For example, if a client wants co-members in their LLC, they can draft an operating agreement that will:
Protect them from claims if the other members ever turn against them; and
Make it easy to remove the other members.
Q: How are LLCs taxed?
Like LLC law, the federal taxation of a limited liability company and their members is characterized by extraordinary flexibility.
Single-member LLCs whose members are individuals. Single-member LLCs are considered to be “disregarded entities” by default. Disregarded entities are ignored for federal tax purposes and their tax items are treated as those of their members. If the owner of a disregarded single-member LLC is an individual, all income of the LLC will be taxable to the owner as a sole proprietor under the default rules. If the owner of a disregarded entity is an entity, all income of the LLC is reported on the owner’s tax return. While the default rules are often the best choice for tax purposes, the LLC can elect to be taxed as a subchapter C corporation or, if all requirements are satisfied, as a subchapter S corporation.
Disregarded entities allow the creation of multiple levels of liability protection without additional tax complexity. If a client’s new business will have valuable operating assets, they should consider using a holding and operating company where:
The holding company will be either a single-member or a multi-member LLC, depending on whether they want to add additional members; and
The operating company will be a single-member LLC and will be owned by thier holding company and ignored for tax purposes as a disregarded entity.
Multi-member LLCs. By default, multi-member LLCs are taxed as partnerships under IRC Subchapter K. Subchapter K is often the best choice of tax regime for most businesses with multiple members, but multi-member LLCs can also elect to be taxed as C corporations or, if they meet applicable eligibility and election requirements, as S corporations.
Social Security Taxation. The owners of S corporations only pay Social Security and Medicare taxes on the portion of the corporation’s income that is treated as compensation. All non-salary distributions are not subject to Social Security and Medicare taxes. In the right circumstances, the ability to treat an LLC as a subchapter S corporation can help LLC owners save Social Security and Medicare taxes. If a client’s LLC will have employees or significant capital investment and they want to minimize Social Security Tax exposure, Subchapter S may be the ticket.