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Limited Liability Corporations

Many agents have already heard about the new business entity, the LLC, that has been adopted in 47 states and the District of Columbia (exceptions are Hawaii, Mass. and Vermont). But few agents understand the concept and the benefits of this hybrid form of corporation, begun in 1977 in Wyoming.

Until recently your choices of business form was limited and each type of business carried risks as well as benefits. Sole proprietorships were easy to form and income was taxed only at the level of the proprietor. However, the proprietor is also personally liable for debts and obligations of the business.

In a General partnership the economic benefits of the company is allocated among the partners. Each partners income is taxed at the partner’s rate, but, like sole proprietors, each partner assumes liabilities for the obligations of the business.

C Corporations income is taxed twice, one at the corporate level and again to its shareholders upon distribution of profits. However, the corporation assumes the responsibility for its liabilities and obligations, not the individual owner.

S Corporations are taxed like partnerships (avoiding the double taxation of C Corporations) and benefit their shareholders with limited liability. On the other hand S Corporations maintain significant restrictions on ownership. They may have only 35 owners and can not be owned by corporations, qualified retirement plans, trusts and non-resident aliens. While the foregoing restrictions are not truly significant to most insurance agency S

Corporations, agencies classified as personal service corporations may find the corporate protection pierced in the event of a lawsuit.

The LLC combines the advantages of both the corporation and the partnership. And in 1988 the IRS rules that a Wyoming LLC could be classified as a partnership for federal income tax purposes avoiding the double taxation issue while also avoiding the personal liability to its owners. Because the LLC eliminates all restrictions on ownership as well, the IRS’ ruling opened the flood-gates on legislation in the states to adopt the new form of corporation.

The only restriction on the LLC is that it must satisfy no more than two of the four corporate characteristics: limited liability, centralized management, free transfer ability of ownership, and continuity of life. The reason for this restriction is to differentiate the LLC from other forms of corporation. Since LLCs are normally formed for the benefit of limited liability, the other three factors must be carefully considered.

Central management exists if management of the business rests with some, but not all of the owners (or in a Board elected by the owners). Free transfer ability means that an owner can transfer his ownership without the consent of the other owners. Continuity of ownership means that the business goes on after the death, retirement (or other forms of departure) of an owner.

As you can tell, Uncle Sam still doesn’t give us something for nothing.

In order to insure that their LLCs meet the “two or fewer” requirement, the states have enacted two forms of LLC, “Bulletproof” and “Flexible”. The bulletproof LLC automatically gives the corporation partnership tax treatment but the characteristics selected are fixed for the life of the corporation. Flexible LLCs permit the business owners a degree of flexibility in the characteristics it selects (as long as it ;meets the “two or fewer” rule).

LLCs can have as many owner as it wants, but you can not have a one owner LLC because it could not be considered a partnership (the form of tax basis used for the entity). So, you should consider two the minimum number of owners in this entity.

If you like the potential benefits of an LLC for you, contact your attorney. In many states an existing partnership can convert to an LLC tax free. Corporations can be converted, but, depending on the state, you may have to liquidate the existing corporation and distribute the assets to the LLC. This may be a taxable event, but there are ways to minimize the taxes as well.

The main downside to the LLC is that it is new and untested. The challenges and court cases have set no precedent to date and, as a result, the states will apply the new laws as they choose. However, the benefits of the LLC seem to overshadow it’s weaknesses. We suggest that you investigate the LLC for your business form.