BRIEF SUMMARY AND INTRODUCTION: Until just a few
years ago, the only choices of legal entity for a business were
generally: "To incorporate, or not to incorporate." However,
in recent years, all 50 states have adopted limited liability company
(LLC) laws, offering a very attractive new alternative that every
small business, including the smallest home-based business, should
now consider. In addition, every state but one has also created a
somewhat similar new type of business entity, the limited liability
partnership, or LLP.
This web page, excerpted from Ronin Software's authoritative
Small Business Advisor software program,
will guide you through the pros and cons and ground rules for
operating your business in the form of an LLC or LLP, including
some of the specifics of state-by-state laws dealing with LLCs
and LLPs. This page represents only a small sample of the
comprehensive tax, legal and practical business advice found in
the Small Business Advisor program (free to download),
all written in non-legalese.
This web page will help to guide you through some of the pros and cons
and ground rules for operating your business in the form of an LLC or LLP,
including some of the specifics of state-by-state laws dealing with LLCs
and LLPs.
EVERYTHING YOU EVER WANTED TO KNOW (AND PROBABLY MORE)
ABOUT LIMITED LIABILITY COMPANIES AND LIMITED LIABILITY PARTNERSHIPS
By: Michael D. Jenkins, Esq., J.D., CPA. Mr. Jenkins is a
graduate of the Harvard Law School, and has practiced as a tax attorney
with the firm of Cooley, Godward, et al, in San Francisco, as a CPA and
Tax Supervisor with Peat, Marwick in Los Angeles, and as a tax partner
in a large local CPA firm in the San Francisco Bay Area. Since 1980,
he has been the author and principal editor of the million-selling
state-specific book series, "Starting and Operating a Business
in.... (state)" (revised and re-published in 2000 as a single
national edition, "Starting and Operating a Business in the U.S.," with
a CD-ROM included that contains state chapters for all 50 states and the
District of Columbia -- published by Running 'R' Media.)
However, all of the print versions of those books are now several years
out-of-date -- However, new, updated versions of these books for each state
and D.C. are regularly (weekly) being released and published in electronic
book format by Ronin Software, all updated in 2007 or 2008. One state per week
is fully revised and updated, all year round. Editions for all 50 states and
D.C. are now available -- see our Product Information
page for the Small Business Advisor software that comes as a "front-end"
with each of the "Starting and Operating a Business in ..." (your state)
electronic books.
LIMITED LIABILITY COMPANIES -- A RELATIVELY NEW TYPE OF LEGAL ENTITY:
The age-old choice of entity in starting a business has
always been a threefold one (except for such oddities as the
"Massachusetts business trust"): sole proprietorship,
partnership, or corporation. But now, not only do most
states allow you to change your partnership into a "limited
liability partnership," but there is also a new kind of
business entity, which has recently arrived on the scene:
the "limited liability company."
What, you may wonder, is this LLC entity?
- Is it a corporation? No, not exactly.
- Is it a partnership? Yes, sort of.
- Is it a sole proprietorship? No, not quite.
- Is it recognized in all states? Yes, since Hawaii's
law went into effect on April 1, 1997.
BACKGROUND OF LLCs.
Starting with the
pioneering state of Wyoming in 1977, and ending with the
Hawaii legislature in 1996, every state has, in recent years,
now passed laws creating a new type of legal entity called a
"limited liability company" (or LLC). These new
entities, which resemble (and are usually taxed as)
partnerships, offer the advantages of limited liability,
like corporations. While it has long been possible for
partnerships to offer limited liability to their LIMITED
partners, a limited partnership always had to have at least
one GENERAL partner, who was fully liable for the debts of the
business.
The new "limited liability companies" have, in effect,
done away with the need to have unlimited liability for ANY of
the owners of what is, in essence, a partnership form of
business organization.
In addition, all 50 states and D.C. have now adopted a
similar type of entity, the limited liability partnership
(LLP) or registered limited liability partnership (RLLP).
The LLP (or an RLLP) is simply a garden variety partnership
that registers with the state and pays a specified fee, in
order to become an LLP or RLLP and to have limited liability
conferred upon the partnership, which is generally quite
similar to an LLC, except that it may be operated like a
regular partnership, for the most part.
However, LLPs are mostly used for professional firms, and
in some states (New York, California) only professional firms
may set up LLPs. For professionals, the LLP offers only somewhat
limited protection from liability, in that a professional who
is a partner in an LLP remains personally liable for his or her
own malpractice or gross negligence, or such misdeeds committed
by employees of the LLP who operate under that partner's direction.
(The same is generally true of professional corporations or
professional LLCs.)
I.R.S. CHECK-THE-BOX-REGULATIONS OPEN THE DOOR WIDE
FOR LIMITED LIABILITY COMPANIES.
It was not until 1988
that the Internal Revenue Service finally ruled that LLCs
created under a new LLC law in Wyoming could qualify for tax
treatment as a partnership, rather than as a corporation,
even though they offered limited liability protection to the
owners, much like a corporation. However, the IRS laid down a
strict set of highly technical rules that LLCs had to follow,
if they were to avoid being subject to corporate income taxes.
This tended to discourage the use of LLCs by all but the most
adventuresome businesses, for a number of years. Because of the
complex tax requirements of the IRS rules, many lawyers, other
than a few tax lawyers, were reluctant to attempt to set up LLCs
for their small business clients. In addition, the IRS took the
position that a one-owner LLC would be taxed as a corporation in
all instances.
However, in 1997, the IRS opened the floodgates when it
issued a new set of regulations that basically allowed any
LLC to choose whether it wished to be taxed as a partnership
or a corporation, simply by filing an IRS form and "checking
the box" as to what kind of taxable entity it wanted to be.
The new "check-the-box" regulations also allowed one-owner
LLCs, for the first time, to escape corporate tax treatment, and
instead be ignored as entities for tax purposes, the same as a
sole proprietorship.
The regulations provide that any newly formed "eligible
entity" (which excludes corporations and, in most cases,
banks) will be treated by default as a partnership, unless
the owners or members of the eligible entity elect corporate
tax treatment, by filing Form 8832. A noncorporate entity
with only one owner, such as a one-person LLC, will be
treated as not being an entity that is separate from its
owner -- that is, its existence will be ignored -- unless
the owner elects corporate tax treatment. Thus, a sole
proprietorship that becomes an LLC will continue to be
treated as a sole proprietorship by the IRS, and an LLC
set up by a corporation will be treated as just another
branch or division of the corporation, and not treated as
a separate legal entity.
The IRS will also continue to honor the noncorporate tax
status of any entity that was reporting as a noncorporate
entity (such as an LLC reporting as a partnership) before
1997, generally.
An existing eligible entity, if previously treated as a
corporation before 1997, is now able to elect noncorporate
status by simply filing Form 8832 with the appropriate IRS
service center, specifying the date the election is to
become effective, provided the date is not more than 75
days after, or 12 months prior to, the date of filing. If
no date is specified on the form, the election becomes
effective on the date filed. A copy of this form must be
attached to the tax return of the person or entity filing
the form for the first year in which the election is in
effect. (Note, however, that such a change from corporate
to noncorporate status would be the equivalent of a
corporate liquidation, with potential capital gains or
other taxable income resulting at both the corporate and
owner level at the time of such changeover. Don't make
such a change without first consulting a competent tax
advisor, as the tax consequences can be severe in certain
situations.)
This new set of IRS regulations was a truly revolutionary
change in the very old and long-established ground rules
for choosing a legal entity.
Under the "check-the-box" regulations, there is
very little reason for any business with more than one owner to
operate in "naked" form, without limited liability,
as a partnership. Also, since the 1997 "check-the-box" IRS
regulations went into effect, the states which still required
an LLC to have at least two members have since amended their
LLC laws to permit formation of one-member LLCs.
Now that all of the states allow one-member LLCs, it makes
good business sense for almost any sole proprietor to become
an LLC, since the IRS will ignore the existence of the LLC
and continue to treat its income as being earned by a sole
proprietorship. In short, you will gain the benefits of
limited liability for your sole proprietorship without any
increase in your federal tax compliance chores or any changes
in your tax liability. By contrast, if you incorporate
your business to gain limited liability, you become subject
to a whole host of federal and state income and franchise
tax burdens, plus much more complicated tax compliance
requirements. (Of course, there are still situations when
certain corporate tax advantages may outweigh such disadvantages.
For example, S corporation status is often preferable to an
LLC for professional firms, since profits not paid out by an
S corporation as salary will not be subject to self-employment
tax.)
It is also becoming standard practice for any form
of business, including sole proprietorships, partnerships
or corporations, to create separate LLCs for any new business
ventures, such as new stores for a retail chain, so that
the failure of such a new store or other venture will not
devastate the entire company. This could be accomplished
in the past by setting up multiple corporations for each
such business segment, but the heavy accounting, legal, and
tax return compliance costs of setting up and maintaining
numerous corporations has generally made that strategy
prohibitively expensive for all but quite large businesses.
Under the new set of ground rules, the main business
entity can now set up a series of subsidiary LLCs that create
"fire walls" between different segments of the
business, but which can be totally ignored for federal tax
filing purposes -- the main business will still file one
partnership or corporate tax return (or file one Form 1040
with one or more Schedule C's, in the case of an individual
owner), combining the results of all the separate "sole
proprietorship" LLCs on the single tax return. No multiple
tax returns, no horrendously complex consolidated corporate tax
returns and intercompany accounting will be required for such
arrangements -- a very clean, very simple, and very effective
way to reduce your liability exposure to creditors!
However, be aware that it will still be necessary to keep
separate accounting records and bank accounts for these LLCs,
as each will be a separate legal entity. Otherwise, creditors
might be able to "pierce the veil" of limited liability
if the LLC's assets are commingled with yours or with assets of
another entity, or if you do not otherwise consistently treat the
LLC as a separate business entity. Also, most states require some
kind of annual report to be filed, along with filing fees, by all
LLCs doing business in the state, so that any LLC will require some
additional paperwork, besides keeping separate accounting records.
In addition, a few states, such as Texas and Tennessee, subject
LLCs to corporate income taxes, and some states with only a franchise
tax (on capital), such as Wyoming, impose the franchise tax on LLCs
as well as on corporations. Others, like New Hampshire and
the District of Columbia, impose an income tax on all businesses,
including unincorporated ones. California imposes an "LLC fee"
each year on LLCs, based on their gross receipts, if in excess of
$250,000.
NOTE RE SINGLE-MEMBER LLCs:
Not all state tax laws initially conformed to the IRS "check-the-box"
regulations, so it was possible that a one-owner LLC could be treated
as a corporation under such states' income tax laws, until conforming
legislation was enacted. Also, a few states' LLC laws did not recognize,
or permit the formation of, single-owner LLCs, at the time the IRS
regulations were promulgated.
Now, however, all 50 states permit one-owner LLCs, though some
states still tax LLCs like corporations.
The upshot of these major law changes has not been to make
S corporations, sole proprietorships, and general partnerships
"endangered species," however, almost every small
business is now able to gain some measure of limited liability
protection by adopting either LLC or LLP formats, without need
of incorporating or paying corporate-level federal income taxes.
While single-member LLCs generally are accorded very favorable
and flexible tax treatment, it is not always entirely clear whether
an LLC is a "single-member LLC" LLC or not, in a community property
state like California, where the "single owner" is a married person,
which means the owner's spouse may also have an ownership interest,
as community property, in the LLC. Fortunately, the federal Internal
Revenue Service has taken a very lenient position in Rev. Proc.
2002-69, stating that the IRS will accept whatever choice the couple
make, either to disregard the LLC as an entity (treating it as a
"single-member LLC") or to treat it as a partnership between the
husband and wife. Presumably, the couple's choice of federal tax
treatment will also generally apply for state tax purposes, since
most states with income taxes follow the federal tax treatment
of LLCs, generally. (The nine community property states are
Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas,
Washington and, since 1986, Wisconsin.)
However, where the LLC is owned by a husband and wife as joint
tenants, or tenants in common, or as tenants by the entirety, it
is unclear whether the IRS treatment would be as lenient as for
community property owners, since the IRS has not yet issued any
published rulings on whether an LLC can be a disregarded entity
if held in one of the various forms of tenancy by a married
couple, rather than being held as community property. Thus,
it is also unclear, where an LLC is owned by a husband and
wife as co-tenants, whether a state would treat the LLC as
a single-member LLC or as a partnership.
Since your lawyer no longer needs to be a rocket
scientist or tax genius to properly set up an LLC that
qualifies for noncorporate tax treatment, the legal costs
of forming an LLC have come down quite a bit in recent years,
due to the explosive growth in the number of businesses
or professional practices operating as LLCs (although not
all states allow professional LLCs, and California prohibits
most businesses that require a state license of any kind from
operating as an LLC).
Note, for example, that in Rev. Rul. 95-37, the IRS has
ruled favorably that an existing partnership may generally
be converted, tax-free, to an LLC (if the LLC qualifies for
partnership tax treatment). In fact, such a conversion can
be done without terminating the partnership's taxable year
(the LLC is simply treated as a continuation partnership) and
without need to obtain a new Federal Employer Identification
Number. In many states, a simpler approach may be to merely
register the partnership as an LLP, however, where state law
permits, and where the liability protection that is offered
by an LLP is comparable to that of an LLC.
Be aware that, if an LLC is treated as a partnership,
the members may be subject to self-employment tax on their
earnings from the partnership. However, proposed IRS 1997
tax regulations (which have never been finally adopted)
would have generally treated members of an LLC like limited
partners in a limited partnership, so that certain members of
an LLC would not be subject to self-employment tax on their
distributive share of earnings from the LLC. However, under
those proposed, but never adopted, regulations, a member of
an LLC that elected to be taxed as a partnership (or a partner
in a limited partnership) would be treated as earning
self-employment income if any of the three following
conditions applied to the member:
- He or she has personal liability as a partner
of the partnership for debts or claims against it
(this would generally only apply to a general
partner in a limited partnership, not an LLC);
- The member has authority to contract on the LLC
or partnership's behalf under the law of the state
in which the LLC or partnership is organized; or
- The member participates in the entity's trade
or business for more than 500 hours during the tax
year. [Prop. Regs. Sec. 1.1402(a)-2(h)(2), proposed
in 1997 but never adopted or revised since]
Even if a member of an LLC participates more than 500 hours
a year in the LLC's business, his or her distributive share
of the profits may not be subject to self-employment tax,
although any "guaranteed payments" received from the
LLC for services would be. Thus, part of a member's income
from an LLC could be subject to self-employment tax, while
part is not, under the (never finalized) Proposed Regulations.
However, in service partnerships engaged in activities
such as legal or medical services, accounting, architecture,
engineering, actuarial or consulting services, anyone who
provides more than a minimal amount of such services would
not qualify for treatment as a "limited partner" for
purposes of the above exemption from self-employment tax
on his or her income from a limited partnership or LLC.
Unfortunately, the status of the tax law regarding the
application of the self-employment tax to members of an LLC
is still very much up in the air, since the IRS came under
heavy criticism for the Proposed Regulations, which Congress
order the IRS not to finalize or implement before July, 1,
1998. The IRS has not to this date set forth any new Proposed
Regulations or other pronouncements on this controversial subject,
and has never implemented the Proposed Regulations.
As a general rule, many tax practitioners today believe
that an LLC member is not subject to self-employment tax on
his or her income if the member is not a manager of the LLC
and that, generally, 10% or less owners of an LLC are not
subject to self-employment tax unless they receive a guaranteed
payment (like a salary) from the LLC for services rendered, and
not just a percentage share of the LLC's profits. However,
there is no clear answer to this question at present, and
the IRS may not necessarily agree if you treat your share of
income from an LLC as exempt from self-employment tax.
One court case in 2000 that considered whether some LLC members
could be treated like general partners, despite the fact that
all members of an LLC have limited liability, concluded that
members who actively participate in the business were similar
to general partners, and thus their income or loss from the LLC was
not "passive income or loss" under the passive activity tax
rules. Steven A. Gregg, et ux. v. United States,
87 AFTR 2d Par. 2001-311, U.S. District Court, District of
Oregon (November 29, 2000). The IRS had argued in this case
that all the members were similar to limited partners, due to
their limited liability, and that their losses were thus "passive
losses" that could not be deducted against other income.
However, to date no court cases have considered the question of whether
LLC members are subject to self-employment tax or, if so, which
LLC members would be taxed. Since the IRS lost the Gregg case,
they might now try to use that court decision to argue that some LLC members
are also like general partners for purposes of the self-employment tax.
CAUTION:
While it is probably safe to assume that a passive investor
in an LLC, which is not a service business in one of the
professions, performing arts, or consulting, would not be
subject to self-employment tax, or that an active managing
member of the LLC would be subject to self-employment tax,
you should consult a competent tax advisor before you take
the position on a tax return that income you receive from
an LLC is not self-employment income.
Also, beware of much of the information on this question
you will find on the Internet, much of which assumes that the
IRS Proposed Regulations (of which Congress disapproved, but
did not order the IRS to rescind, in the 1997 tax act) are the
law. Sophisticated tax practitioners would beg to differ.
SOME STATES NOW ALLOW "SERIES" LLC'S
Individual entrepreneurs, corporations, or other entities have
learned to utilize multiple LLCs, by putting separate business
ventures in separate LLCs, which allows the owner to isolate the
risks of each venture to the capital invested in that LLC. However,
in many states, such as California, using multiple LLCs means
incurring multiple taxes or other fees or administrative costs,
particularly where the various LLCs have somewhat different
members.
EXAMPLE:
ABC Restaurants, a restaurant chain, might set up a
number of LLCs, one for each restaurant, perhaps with local
partners in each city who own part of the LLC that operates
the ABC Restaurant in that city. The bankruptcy of one of
the LLCs will not affect the parent company or other
owners of any of the other restaurants.
Now, some states, notably Delaware, [Delaware Code, Title 6,
Subtitle II, Sec. 18-215] have amended their LLC laws to allow
"series LLCs." Several other states have enacted similar LLC
provisions, including Illinois, Iowa, Nevada, Oklahoma, and Utah.
A series LLC is a single LLC that divides itself into a
"series" of separate divisions, each of which must keep a
separate set of books, but with each such division or series
operating a separate business, with its own separate limited
liability, so that if the business of one series goes bankrupt,
the other series or divisions of the LLC are not liable for
its losses. In effect, each such "series" of an LLC is like
a separate legal entity, with regard to legal liability, but
only one LLC exists, thus creating only one set of taxes, tax
filings, etc.
Each "series" can even have different members, managers,
and ownership percentages and can make distributions to
its members while other members of the LLC receive none.
However, legal experts are divided, so far, as to whether
other states will respect such series LLCs established
under the laws of, for instance, Delaware. Also, it is not
yet clear whether the IRS will allow such an LLC to file a
single partnership tax return, or will treat each separate
series as a separate partnership, with tax returns required
for each.
Thus, while this new legal development offers significant
potential benefits, you may take significant risks if you
are one of the pioneers who sets up a series LLC, before the
tax and legal treatment of such entities has been sorted out
by the courts, IRS, and state legislatures.
PROS AND CONS OF LIMITED LIABILITY COMPANIES:
Major benefits of LLCs over the traditional business
entities that were available up till now (corporations,
partnerships and sole proprietorships) include the following:
- Unlike a general partnership, owners of an LLC have
limited liability; and, unlike limited partners in
a limited partnership, they do not lose their limited
liability if they actively participate in management.
- Now that the IRS "check-the-box" regulations have
become effective, a business that is currently a sole
proprietorship is also able to change to LLC form and
thus obtain limited liability, with no tax consequences
or added tax compliance requirements of any kind, as
the IRS will now, in effect, ignore the existence of
the one-owner LLC for tax purposes.
- Like a regular corporation (a C corporation), an LLC
provides limited liability to its owners, but taxable
income or losses of the business will generally pass
through to the owners (but any such losses may not
always necessarily be deductible, due to the "at-risk"
and "passive loss" limitations of the tax law).
- An LLC is more like an S corporation, in that it
provides for a pass-through of taxable income or losses,
as well as limited liability, but can qualify in many
situations where an S corporation cannot, since an S
corporation cannot:
- have more than 100 shareholders;
- have nonresident alien shareholders;
- have corporations or partnerships as
shareholders;
- own 80% or more of the stock of another
corporation;
- have more than one class of stock (or otherwise
have disproportionate distributions); or
- have too much of certain kinds of "net passive
income."
- Also, LLC owners may be able to claim tax losses
in excess of their investment, such as on certain
leveraged real estate investments, which would not
ordinarily be possible in the case of an S corporation
or even a limited partnership.
- LLCs are (generally) simpler entities to maintain
than corporations. An LLC is required to file its
"articles of organization," which are similar
to articles of incorporation, but the operational
similarities tend to end there. It is also a good
idea for an LLC to have a written operating agreement,
which spells out how the company is to be operated,
much like a partnership agreement. However, from
that point on, the LLC is governed by its operating
agreement, and there is generally no need for any
of the tedious corporate formalities such as minutes
of meetings, resolutions and annual meetings of the
shareholders ("members" in the case of an LLC).
This operating flexibility, in addition to freedom from
corporate level income tax (except in the few states
that impose state income taxes on them) makes the LLC
a highly advantageous form of doing business for the
closely-held or family-owned business.
On the other hand, most of the LLC statutes have had
certain built-in disadvantages, as compared to S corporations
or other corporations, such as the fact that LLCs must usually
provide in their articles of organization that the entity
will terminate in not more than 30 years, and the fact
that an LLC must (generally) have more than one owner,
unlike corporations. (But many of these provisions have
already been repealed by most of the states, now that the
IRS final regulations have made such restrictions unnecessary
for federal income tax purposes. In particular, the two-member
requirement has now been repealed in every state and D.C.)
Even the federal tax treatment of LLCs is no longer
uniformly favorable. Perhaps unintentionally, a new
partnership tax law provision that was added in the Revenue
Reconciliation Act of 1993 may adversely impact professional
service firms that are organized as LLCs, rather than as true
partnerships. Under the 1993 tax law amendments, certain
payments made by partnerships to outgoing partners (for
"goodwill" or "unrealized receivables") are
no longer deductible to the partnership, except when made
to a general partner in a service partnership, such a a law or
medical partnership.
Since LLCs, if properly organized, are treated as
partnerships for income tax purposes, this 1993 law applies
equally to professional service firms that are either
LLCs or partnerships.... With one important Catch-22: Since
an LLC has NO general partners (all of its partners have
limited liability, like limited partners), then NO payments
(for goodwill, etc.) by an LLC to buy out one of its members
can qualify as deductible under the 1993 tax law change.
This can be a serious tax disadvantage for a professional
service firm that operates as an LLC, rather than as a
partnership. (Furthermore, some states with LLC laws do
not allow professional service firms to operate in
the LLC form.)
Professional firms will often find it preferable to
operate in the form of professional corporations, and
S corporation status, rather than as LLCs, since all
the earnings of a professional LLC will generally be
subject to self-employment tax. If operating as an S
corporation, only the salaries paid will be subject to
FICA taxes (at the same rate as self-employment tax),
and any remaining profit that is earned by the S
corporation will be subject only to income tax, not
to self-employment or FICA taxes, provided that the
amount of salaries paid is not unreasonably low and
subject to treatment as tax avoidance by the IRS.
Another disadvantage of an LLC is that an LLC may need
to file as a tax shelter if it has members who are
treated as limited partners or “limited entrepreneurs”
(persons who are not limited partners but who do not
actively participate in the LLC's management).
In addition, some states, which have corporate income
taxes or franchise taxes based on income, treat LLCs as
corporations for state income tax purposes. This can result
in double state taxation of income in such states, if you
distribute income, since the distributions will be treated
as taxable dividends to the recipients, after being taxed
once already at the LLC level, or, in states like Texas or
Tennessee, which have no personal income tax, can result in
at least one layer of state tax on income, which would not
otherwise be incurred with either a regular partnership or
a sole proprietorship.
Also, some states impose other income-based taxes at the
entity level on LLCs, just as for corporations, such as
the Michigan Single Business Tax or the Illinois Personal
Property Replacement Tax. Other business entity gross income
or net income taxes such as in Washington, D.C., Washington
state, New York City, and New Hampshire, also apply equally
to LLCs and other unincorporated businesses, as well as to
corporations.
Even so, LLCs seem to have many advantages that almost
guarantee a continued boom in their popularity in coming years.
LIMITED LIABILITY PARTNERSHIPS.
As noted above, all of the states and D.C. have now adopted
limited liability partnership (LLP) laws that provide for an entity
similar to an LLC, with limited liability, that can usually be
formed simply by registering an existing partnership. Wyoming,
the first state to adopt an LLC law, was the last state to adopt
an LLP law.
To form an LLP, it is generally not necessary to file any written
articles of organization or have a written partnership agreement, or
to comply with certain other formalities that are required of an
LLC. However, if possible, you may wish to form a limited liability
limited partnership, or LLLP, a somewhat more formal entity that is
now allowed in a number of states.
An LLLP is simply a limited partnership (which means a written
limited partnership agreement and registration for a certificate of
limited partnership are generally required) that elects to become an
LLP as well. The advantage of an LLLP is that the general partners
obtain the limited liability protection of an LLP, so that none of the
partners, general or limited, in an LLLP have any personal liability,
as a rule.
A few words of caution about LLPs and LLLPs are in order, however:
- In some states, such as New York, Nevada, and California,
the LLP law allows only certain professional service firms to
elect LLP status, although most states with LLP laws now
allow any type of business general partnership to elect
limited liability status (and a few states also allow limited
partnerships to do so).
- If your business is a partnership that is eligible to
convert to LLP status, be sure if you do so that you don't
simply adopt your existing partnership agreement as the LLP's
operating agreement. For example, if your partnership agreement
has provisions that require a partner with a negative partnership
capital account to make up such a deficit, such a provision in
your LLP's operating agreement could open a "swinging back
door of liability" for partners in your LLP, defeating your
primary goal of having a limited liability legal entity (although
the laws in some states now protect an LLP against such an
oversight).
- In some states, you will be required to take out large
liability insurance policies for negligence or other
wrongful acts of the LLP or its partners, as part of
the price you must pay to the benefits of limited
liability.
- In some states, the LLP law offers less liability
protection than a corporation or LLC. That is, an
LLP only protects you from negligence, wrongful acts
or other such misconduct of the other partners, and
not from your own malpractice, negligence or other
misconduct. However, more and more states are adopting
the Revised Uniform Partnership Act, which provides
much better liability protection to partners in an
LLP (except for malpractice liability in a professional
LLP, generally).
- Most states do not yet allow limited partnerships to
become LLLPs.
STATE NOTES ON LLC LAWS:
As noted above, every state in the U.S., has now adopted
a limited liability company (LLC) law, in some form. Thus, in
addition to the traditional choices of a sole proprietorship,
partnership, or corporation, a business may also choose, in
most states, to operate in the form of an LLC. In most states,
LLCs are very attractive entities for many small businesses,
in that they offer the same protection as a corporation from
creditors for debts of the business, while offering much of
the flexibility plus the flow-through tax treatment of a
partnership for federal tax purposes.
However, some states limit the types of businesses that
may operate as LLCs, or impose significant income taxes,
capital taxes, or fees on LLCs. For example, California
severely limits the types of businesses that may operate in
the form of an LLC, and imposes "LLC fees" on LLCs, based
on gross receipts of the business, as well as a $800 annual
minimum tax. Other states, such as Kentucky, Texas and Tennessee,
tax the income and/or capital of an LLC in the same manner as a
corporation, so that there is no state tax advantage of using
the LLC form in those states. The states of New York and New Jersey
impose a hefty fee on most LLCs, based on the number of members
(owners) of the LLC, up to a maximum fee of $25,000 in New York
or $250,000 in New Jersey, and Ohio is phasing out its corporate
franchise tax and replacing it with a "Commercial Activities Tax,"
a gross receipts tax that applies equally to all types of legal
entities.
Still other states, such as New Hampshire and Michigan, or
the District of Columbia, as well as New York City, tax the income
of all business entities in more or less the same manner, regardless
of the legal form of the business, so that the LLC form provides no
state tax advantages in those states.
The following paragraphs provide general information on
LLC organizational requirements and state taxation in several of
the various states.
ALABAMA. To form an LLC in Alabama, you must file
articles of organization with the Office of the Probate
Judge, with a copy of the articles for the Probate Judge to
certify and deliver to the secretary of state. You must pay
a $35 filing fee to the Probate Judge and another $40 filing
fee for the judge to forward to the Alabama Secretary of
State. Foreign LLCs that do business in the state must
register with the secretary of state, paying a $75 fee for
filing the foreign LLC registration, in order to obtain a
certificate of registration to do business in Alabama.
For information on LLCs in Alabama, contact the Corporate
Section of the office of the Alabama Secretary of State.
Alabama state law generally follows federal tax rules
with regard to tax treatment of LLCs, and now permits the
formation of 1-member LLCs. Effective since 1998, Alabama
treats LLCs as partnerships unless they are otherwise
classified for federal tax purposes, and disregards a
1-member LLC if it is disregarded for federal tax purposes.
While LLCs are generally not subject to state income tax
in Alabama, all LLCs, including 1-member LLCs that are
"disregarded entities" for income tax purposes, are subject
to the Business Privilege Tax [hyper-text link disabled]
that applies to corporations and other limited liability
entities that do business in Alabama.
See Section IV(c) of this chapter [hyper-text link disabled]
for a discussion of the income tax treatment of LLCs under Alabama tax
laws, and of the Alabama Business Privilege Tax that now applies
to LLCs.
For more information on filing articles of organization
for an LLC, see the contact information for the offices of
the secretary of state, listed in Section VI(a) [hyper-text
link disabled] of the State Chapter of "Starting and
Operating a Business in Alabama."
ARIZONA. To form an LLC under the laws of Arizona, one
or more persons (who need not be members of the LLC) must file
articles of organization with the Secretary of State, along
with a $50 filing fee. Foreign LLCs that do business in the
state must register with the Secretary of State, paying a $150
fee for filing the foreign LLC registration, in order to obtain
authority to do business in Arizona. [ARIZ. REV. STAT. ANN.
Sec. 29-851]
Unlike some states, Arizona law permits the formation of
professional LLCs. [Ariz. Rev. Stat. Ann. Sec. 29-841]
Arizona state law now permits the creation of 1-member
LLCs, in response to the fact that the federal tax regulations
have been modified to allow 1-member LLCs to be treated as
sole proprietorships for federal tax purposes.
[Ariz. Rev. Stat. Ann. Sec. 29-601(10)]
As with LLPs, LLCs formed in Arizona or foreign LLCs that
register to obtain authority to do business in the state must
publish a notice in local newspapers and file an affidavit
with the Secretary of State of Arizona within 90 days, as
proof of publication. [Ariz. Rev. Stat. Ann. Sec. 29-635(C)]
For more information on filing articles of organization
for an LLC, see the contact information for the offices of
the Arizona Corporation Commission, Corporations Division,
listed in Section VI(a) [hyper-text link disabled]
of the State Chapter of "Starting and Operating a Business in
Arizona."
In Arizona, a limited liability company (LLC) is taxed
in the same manner as a partnership, thus avoiding the
possible double taxation of income that can occur with a
corporation. Note that under IRS regulations, effective
since 1997, an LLC is now able to elect to be treated as
a partnership if it has more than one owner, or as a sole
proprietorship if it does not, for federal tax purposes.
Arizona law was amended in 1997 to permit the formation
of a one-owner LLC. [Ariz. Rev. Stat. Ann. Sec. 29-601(10)]
ARKANSAS.To form an LLC under the laws of Arkansas, one
or more persons must file articles of organization with the
Arkansas Secretary of State, which must be accompanied by
filing fees of $50. Foreign LLCs, those formed under the
laws of another state, must obtain a certificate of authority
to do business in Arkansas, by filing an application for a
certificate of authority with the Arkansas Secretary of
State and paying a filing fee of $300. [Ark. Stat. Ann.
Sec. 4-32-1301 (1987)] The filing fees are reduced by 10%
for persons who file electronically, under a new fee schedule
that went into effect on January 1, 2006.
LLCs, like corporations, are also subject to the Arkansas
franchise tax, but LLCs pay only a flat annual tax of $150.
[Ark. Stat. Ann. Sec. 26-54-104(a)(8)]
See Section IV(c) [hyper-text link disabled]
of this Arkansas state chapter for a discussion of the income
tax treatment of LLCs under Arkansas tax laws.
Note that Arkansas was one of the first few states that
allowed an LLC to be owned by only one person, and even
provided that such an LLC would be treated like a sole
proprietorship for state income tax purposes. IRS Regulations
[I.T. Regs. Sec. 301.7701-3] were finally amended when
the IRS eventually came around to this position, and now also
permit one-person LLCs to be taxed as sole proprietorships
for federal income tax purposes, as well.
For more information on filing articles of organization
for an LLC, see the contact information for the offices of
the Arkansas Secretary of State, listed in Section VI(a)
[hyper-text link disabled] of this State Chapter.
MONTANA. To form an LLC under the laws of Montana, one
or more persons must file articles of organization with the
secretary of state, which must be accompanied by a filing
fee as set by the secretary of state, currently $70.
[MCA Sec. 35-8-201]
Montana state law was previously not entirely clear as
to whether it permitted the formation of one-owner LLCs,
but the LLC law has been amended, effective since April 12,
1999, and now clearly permits one-owner LLCs. [MCA Sec.
35-8-201] Single-owner LLCs are "disregarded entities"
for federal and Montana tax purposes. However, unlike most
states, Montana requires all disregarded entities, including
single-owner LLCs and certain S corporation subsidiaries,
to file an annual Disregarded Entity Information Return,
Form DER-1. The only exception is for a single-member
LLC, where the sole owner is an individual who was a full-year
Montana resident during the applicable reporting period.
[Per Form DER-1 instructions on Dept. of Revenue website, 7/05]
Foreign LLCs, those formed under the laws of another state,
must obtain a certificate of authority to do business in
Montana, by filing an application for a certificate of
authority with the secretary of state and paying an entrance
fee of $70.
In addition to initial filing fees, an LLC formed in
Montana must subsequently file annual reports by April 15th
with the secretary of state and pay an annual report filing
fee of $15 with each such annual report. A foreign LLC is
also required to file an annual report and pay the applicable
filing fee of $15. [MCA Sec. 35-8-208] Annual report
filing fees are doubled, to $30, if filed after April 15th.
For more information on filing articles of organization
for an LLC, see the contact information for the offices of the
secretary of state, listed in Section VI(a) [hyper-text link disabled]
of the State Chapter of "Starting and Operating a Business in
Montana."
NEW HAMPSHIRE. To form an LLC under the laws of New Hampshire, one or
more persons must file a certificate of formation, Form LLC-1,
with the secretary of state, which must be accompanied by a
filing fee of $50. [NHRS Sec. 304-C:81]
New Hampshire state law also allows formation of one-owner
LLCs, which qualify for treatment as sole proprietorships for
federal tax purposes. [NHRS Sec. 304-C:1-(V)]
Foreign LLCs, those formed under the laws of another state,
must obtain a certificate of authority to do business in
New Hampshire, by filing an application for a certificate of
authority, Form FLLC-1, with the secretary of
state and paying a filing fee of $50. [NHRS Sec. 304-C:81]
In addition to initial filing fees, an LLC formed in New
Hampshire must subsequently file annual reports and pay an
annual report filing fee of $100 with each such annual
report. A foreign LLC is also required to file an annual
report and pay the applicable filing fee of $100. A $25
per month late filing fee applies to any late filing of
an annual report or late payment of the annual fee.
[NHRS Sec. 304-C:81]
[NHRS Sec. 304-C:81]
For more information on filing a certificate of formation
for an LLC, see the contact information for the offices of the
secretary of state, listed in Section VI(a) [hyper-text link disabled]
of the State Chapter of "Starting and Operating a Business in
New Hampshire."
NEVADA. As with other forms of business in Nevada, state
income taxes are not a concern for LLCs, since there is no state
income tax of any kind, corporate or individual, in Nevada.
However, your LLC will need to obtain a state business license
(discussed in Section IV(b) [hyper-text link disabled])
before it may legally commence doing business. Also, LLCs and
all other forms of business that have employees are subject to the
Nevada Modified Business Tax, which is based on the company's
gross payroll. For more details on this tax, which was temporarily
reduced from July 1, 2005 to July 1, 2007, see
Section IV(b) [hyper-text link disabled].
To form an LLC under the laws of Nevada, one or more
persons must file articles of organization with the Nevada
Secretary of State, which must be accompanied by a filing
fee of $75. [NRS Sec. 86.011, et seq.; Sec. 86.561]
Nevada state law was amended to recognize the validity
of single-member LLCs, once the federal tax regulations were
revised by the U.S. Treasury to grant non-corporate tax
treatment to single-member LLCs. [NRS Sec. 86.151(3)]
Foreign LLCs, those formed under the laws of another state,
must obtain a certificate of authority to do business in
Nevada, by filing an application for a certificate of
authority with the secretary of state and paying a filing
fee of $75. [NRS Sec. 86.561]
In addition to initial filing fees, all LLCs operating in
Nevada, both domestic and foreign, must subsequently file
an annual list of managers (or members, if no managers)
and designation of registered agent, plus pay an annual
report fee of $125 with each such annual report, as well
as with the initial list filed at the time of formation
or registration. [NRS Secs. 86.263 and 86.5461]
Nevada's LLC law was amended in 2005 to provide that a
limited liability company agreement may now establish or provide
for the establishment of one or more designated series of members,
managers or limited liability company interests having separate
rights, powers or duties with respect to specified property or
obligations of the limited liability company or profits and losses
associated with specified property or obligations. Any such series
may have a separate business purpose or investment objective.
[NRS Sec. 86-296]
This provision, in effect, allows a single "series LLC" to be
set up with multiple divisions or "series," each of which can
function like a separate legal entity, as long as separate
accounting is done for each. Thus, each such "series" may contain
a separate business venture, whose losses or bankruptcy will be
walled off, in terms of liability, from the other such divisions
of the "series LLC." In addition, some tax advisors believe such
a single LLC can be set up in place of multiple LLCs and thereby
save significant amounts of state taxes in many states where each
LLC is subject to special taxes or fees. (However, California's
Franchise Tax Board has already announced that in California each
such "series LLC" will be taxable as a separate LLC entity, for
purposes of California taxes or fees that apply to LLCs that do
business there.)
For more information on filing articles of organization
and other requirements for an LLC, see the contact information
for the offices of the Nevada Secretary of State, listed in
Section VI(a) [hyper-text link disabled].
TENNESSEE. In most states, LLCs are very attractive entities
for many small businesses, in that they offer much of the same
protection as a corporation from creditors for debts of the
business, while offering much of the flexibility plus the
flow-through tax treatment of a partnership for federal tax
purposes. However, for state tax purposes in Tennessee, LLCs
are now taxed like corporations on their income, under the
corporation excise (income) tax law, and are also now
subject to the state franchise tax. [TCA Sec. 67-4-2004
and 67-4-2105]
See Section IV(c) [hyper-text link disabled]
of the State Chapter of "Starting and Operating a Business in Tennessee"
for a discussion of the income tax treatment of LLCs under
Tennessee tax laws.
To form an LLC under the laws of Tennessee, one or more
persons may file articles of organization with the secretary
of state, which must be accompanied by filing fees of $50
per member, with a minimum fee of $300 and a maximum of
$3,000. [TCA Sec. 48-203-102]
Also, if the LLC's principal office is in Tennessee, it
must file a copy of the articles of organization with the
register of deeds in the county where its principal office
is located. [TCA Sec. 48-247-103] The register of deeds
can charge a fee of $5.00 plus 50 cents a page for each
page in excess of five.
Tennessee's LLC laws originally did not permit the
formation of domestic 1-member LLCs, but legislation
enacted in 1999 abolished this limitation.
[Senate Bill 917, Public Acts, 1999]
One-member LLCs that are "disregarded entities" for federal
tax purposes are subject to income and franchise tax by
Tennessee, unless the sole owner is a corporation.
Foreign LLCs, those formed under the laws of another state,
must obtain a certificate of authority to do business in
Tennessee, by filing an application for a certificate of
authority with the secretary of state and paying a filing
fee of $300 to $3,000, computed as in the same manner as
when filing articles of organization for a domestic LLC.
[TCA Sec. 48-247-103]
In addition to initial filing fees, all LLCs formed in,
or doing business in Tennessee must subsequently file annual
reports and pay an annual report filing fee of $50 per
member, with each such annual report. The minimum annual
filing fee is $300 and the maximum is $3,000. [TCA Sec.
48-247-103(d)]
Effective as of January 1, 2006, Tennessee enacted the Revised
Limited Liability Company Act, for LLCs established after that date.
The existing LLC law remains in effect and applies to LLCs that were
formed before January 1, 2006. LLCs that are formed under the currently
existing law may elect to be governed by the revised LLC law. To do so,
they must amend their articles of organization.
The Revised Limited Liability Company Act makes a number of
provisions unwaivable, by prohibiting the LLC documents from varying
or eliminating any of the following provisions:
- Notice requirements;
- The potential for personal liability;
- The duty of loyalty by members, or the obligation of good faith; or
- Any rights of any person under the Revised Limited Liability Company Act,
other than the rights of a manager, director, officer, employee, agent,
member, and financial holder.
The new LLC law makes a number of other significant changes, including
the following:
- It expands present law to allow any entity to convert to a domestic
LLC or vice versa. Under the existing law, only a domestic general or
limited partnership may be converted to an LLC, and no provision
existed for converting an LLC to another type of entity.
- It provides that an operating agreement need not be in writing
unless the articles of organization or a written operating agreement
specifically requires otherwise.
- It abolishes the use of "governors" or "board of governors" who can
manage an LLC. Instead, an LLC can now be set up so that it is member-managed,
manager-managed, or director-managed.
- It creates a new concept: The "family LLC," defined as an LLC in which
two or more members of the same family hold, in the aggregate, at least 50% of
the financial rights in the LLC. The new law prohibits a member of a family
LLC from terminating the membership interest in such family LLC. If a member
of a family LLC attempts to transfer the member's interest or financial
rights, the transfer will be null and void.
- It allows a single-member LLCs to continue in existence following the
death or disability of the single member.
For more information on filing articles of organization for an LLC,
see the contact information for the offices of the secretary of state,
listed in Section VI(a) [hyper-text link disabled] of the State
Chapter of "Starting and Operating a Business in Tennessee."
UTAH. To form an LLC under the laws of Utah, articles of
organization must be filed with the Department of
Commerce, Division of Corporations and Commercial Code,
which must be accompanied by filing fees of $52.
[UTAH CODE ANN. Sec. 48-2C-402]
Foreign LLCs, those formed under the laws of another state,
must obtain a certificate of authority to do business in
Utah, by filing an application for a certificate of
authority with the Division of Corporations and Commercial
Code and paying a filing fee of $52. [UTAH CODE ANN. Sec.
48-2C-1604] A foreign LLC will also need to provide a
certificate of good standing or certificate of existence
from the state where the LLC was organized.
Utah state law now recognizes the validity of 1-member
LLCs, which can be advantageous, now that the federal tax
regulations have been modified to allow 1-member LLCs to be
treated as sole proprietorships for federal tax purposes,
beginning in 1997. [UTAH CODE ANN. Sec. 59-10-801]
In addition to initial filing fees, an LLC formed in Utah
must subsequently file annual reports and pay an annual
report filing fee of $12 with each such annual report. A
foreign LLC is also required to file an annual report and
pay the applicable filing fee of $12. [UTAH CODE ANN.
Sec. 48-2C-203]
Under new limited liability company legislation enacted
May 1, 2006, Utah law now allows for an LLC to provide for
"series LLCs" in its operating agreement, each of which can
be a separate, designated division of the LLC that will
be treated as a separate LLC for liability purposes, thus
"walling off" losses from the bankruptcy of one such business
from the other business segments ("series") of the LLC.
For more information on filing articles of organization
for an LLC, see the contact information for the offices of
the Division of Corporations and Commercial Code, listed in
Section VI(a) [hyper-text link disabled] of the
State Chapter of "Starting and Operating a Business in Utah."
WISCONSIN. To form an LLC under the laws of Wisconsin, one or
more persons must file articles of organization with the Department
of Financial Institutions, which must be accompanied by a filing fee
of $130, if filing electronically ($170 if filed on paper).
[WISC. STAT. Sec. 183.0114 and DFI website fee listing, 12/04]
Wisconsin state law allows formation of one-owner LLCs,
which now may qualify for treatment as sole proprietorships
for federal tax purposes.
Foreign LLCs, those formed under the laws of another state,
must obtain a certificate of authority to do business in
Wisconsin, by filing an application for a certificate of
authority with the Department of Financial Institutions
and paying a filing fee of $100. [WISC. STAT. Sec. 183.0114]
In addition to initial filing fees, an LLC is required to
file an annual report and pay the applicable filing fee, which
is $25 for a domestic LLC or $80 for a foreign LLC.
[WISC. STAT. Secs. 183.0114 and 183.120, and increased
fee of $80 per DFI website, 12/04]
For more information on filing articles of organization
for an LLC, see the contact information for the offices
of the Department of Financial Institutions, listed in
Section VI(a) [hyper-text link disabled] of the State
Chapter of "Starting and Operating a Business in Wisconsin."
OTHER STATES' LLC LAWS. The state-by-state summary
of key provisions of LLC and LLP laws for a number of states,
which was previously found here, has partly been removed from
this website. All 50 states' LLC laws (and other business laws
and taxes) are covered in our book series, Starting and Operating
a Business in the U.S., (by Michael D. Jenkins), formerly
published in 2000 but now out of print. A new, electronic
(software) version of this book series for each of the 50
states and D.C. has been recently re-written and updated, and
was been re-published in 2005 by Ronin Software.
All editions have been fully updated each year since.
The new electronic version is much more than a book -- it leads
the user through a short interview about his or her business, and
then creates a fully customized version of the book, based on the
user's business situation, number of employees, type of legal entity,
and other factors, and creates a detailed business checklist of
legal and tax requirements for that specific business.
