Since 1977 the LLC has been a form of corporation that provides the limited liability protection of a corporation for its members while providing them the tax benefits of a partnership, as well. LLC’s were first approved in 1977 in Wyoming and were approved by Hawaii as the last state to provide approval in 1997. LLC’s are created and regulated under state, not federal, laws.
For a number of years LLC’s have grown in popularity among many service industries including the legal, accounting and insurance industries.
As usual, there are benefits and drawbacks to this form of company. In most cases conversions of existing corporation to LLC status involves dissolution of the existing company and will cause a taxable event. This makes LLC status the primary choice of new entities instead of changing entities. An exception is for partnerships. Conversion of partnerships to LLC status is tax-free as long as the partners, in exchange for an interest in the new LLC, recognize no gain or loss and no gain or loss is recognized by the LLC from a contribution of capital associated with the conversion.
1. Profits are passed through the company and taxed to the LLC members, individually. This is the same pass-through as in S Corporations.
2. While a liquidation of either a C Corp or an S Corp is normally a taxable event, liquidation of an LLC is generally tax-free.
3. The LLC offers the liability protection of a corporation and the flexibility of a partnership.
4. An LLC is not restricted to one class of stock and is not limited in number of members (stockholders in a corp)
5. An LLC can allocate profits and losses unequally
6. An LLC offers limited liability to its members.
1. Conversion to LLC status could be a taxable event.
2. Some states do not tax partnerships. LLC’s are taxed (check your state)
3. An LLC must have at least two members (stockholders). Some states do permit single member LLC’s, but those LLCs single member must file tax returns on a Schedule C (as an individual) unless and until they elect status as a corporation. They are not permitted to elect partnership status.
4. Some states limit the life of an LLC (check your state)
5. LLC’s become very complicated for entities operating in more than one state since there is a lack of uniformity in LLC statutes.
6. LLC’s are easier to dissolve than other forms of company and there is greater access to business assets. As a result, minority interest discounts in LLCs for estate planning purposes are generally lower than for a corporation. Minority discounts may be as low as 15% for LLCs compared to 25% to 40% for corporations.
7. LLC earnings are generally subject to self-employment taxes.
8. LLCs can not offer incentive stock options.
9. LLCs can not reorganize tax-free
We have seen many new entities in the insurance industry organize as LLCs or LLP (Limited Liability Partnerships). There are individual cases in which this election is not appropriate, but, in many cases, companies have been organized as C or S corporations instead of as LLCs through ignorance of the benefits of the LLC or LLP.
If you are considering an effort that will result in a new company, we urge you to investigate the LLC form of business entity. For most insurance firms, the benefits of the LLC far outweigh its drawbacks.