LLC’s - Hybrid’s for Business

Mention 'hybrids' these days and people will assume your are talking about cars that get great mileage. Business owner's have long had access to hybrids in another form when it comes to entity selection. LLC's or limited liability companies can be just about anything you want them to be and in business flexibility is generally a good thing. Here is how they work.

LLC's are corporations and must be chartered by the state just like regular corporations. In fact, from the local standpoint there is not so much difference between an LLC and a traditional corporation when it comes to registering to do business in the state. The big difference is in the eyes of IRS. Owners can choose to accept the 'default' IRS classification or they can make an election to be treated in a certain manner for tax purposes.

First the default classifications... an LLC with a single owner (commonly called a single member LLC) will be treated as a sole proprietorship by IRS. In effect the corporation is a "disregarded entity" for tax purposes and the business is treated as if it were unincorporated. This is a good thing for business owners who want the greater measure of personal liability protection provided by a corporation but who are less than thrilled with the increased administrative burden created by a separate taxpaying entity. The state and courts will treat them as a corporation and the IRS will treat them as a sole proprietor.

If the LLC has more than one owner the IRS will automatically treat it as a partnership. Again this provides greater liability protection than a general partnership, without creating the double taxation standard typical of regular corporations. The owners will need to file a partnership tax return and report their respective share of partnership profits on their individual income tax returns.

The above two scenarios explain what happens under the IRS 'default' rules. However, the owners can choose to be taxed differently. For instance a single or multi-member LLC can choose to be taxed as a corporation. Further, after choosing to be taxed as a corporation the LLC can elect S corporation status if it qualifies.

These are the most basic scenarios for LLC use. More advanced situations occur where subsidiaries are incorporated as LLC's that are wholly owned by the parent corporation. This is great from a tax standpoint because the LLC is disregarded as far as IRS is concerned meaning the parent does not have to incur the expense and administrative burden of filing separate tax returns. At the same time the subsidiary is legally distinguishable from the parent and it is much easier to sell or spin-off the subsidiary than if it were unincorporated. Additionally, while IRS may treat the LLC as disregarded the states may consider them separate entities allowing segregation for unemployment and sales tax purposes.

Another arena where LLC's are very popular is international corporate tax planning. Foreign corporations often setup U.S. domestic LLC's to transact business here. Since the LLC's are wholly owned by the foreign parent they are disregarded for US tax purposes allowing the foreign parent to file as a foreign corporation here in the US. At the same time vendors and suppliers are more comfortable dealing with a domestic US corporation and do not have the same withholding requirements that might apply when they do business with foreigners.

We have seen LLC's used in all of these scenarios and we continue to find situations where this unique form of hybrid entity suites business owners better than traditional corporations or partnerships. While LLC's have their advantages there are just as many situations where they are not the best choice. It takes an examination of all the facts as well as the owner's future plans to make the right decision.

Joey Brannon is the founder of Axiom Professional Group, a tax, consulting and accounting firm in Bradenton, Florida. Mr. Brannon is both a CPA and an EA. You can find out more about Axiom by visiting www.axiomcpa.com.