Limited Liability Companies

Limited Liability Companies, or LLC's, have only recently been legislated into existence. As such, considerable discussion has been given to LLC as a business entity. While not for every business, the LLC may provide significant legal and tax advantages for certain business entities.

The LLC offers advantages and benefits not otherwise obtainable when operating as a partnership or as a S corporation. The LLC combines the S corporation characteristics of limited liability for all investors with the income flow through attributes of a pass-through entity, such as a S corporation or a partnership. The LLC, however, does not have the significant restrictions that are required of the S corporation.

Currently, all states have enacted some type of LLC legislation, including Colorado.

An LLC is formed by two or more members, and must have a stated term of existence, generally no more than 30 years. As discussed earlier, the members have limited liability whereby the members are not personally liable for the LLC's debts or liabilities except to the extent of their investment and their capital commitment in the LLC. Interests in the LLC are not freely transferable. Additionally, management is generally in the hands of a manager or management committee that is elected by the members.

A revenue ruling has been issued by the Internal Revenue Service that a Colorado LLC organized to own and operate real estate was a partnership for tax purposes. The American Bar Association has presented a standard act for the LLC similar to the Uniform Partnership Act, that has been adopted by states wanting to implement the LLC.

In determining whether an entity should be classified as a partnership or corporation, the following corporate characteristics are examined: Continuity of life, Limited liability, Transferability of interests, and Centralization of management. The entity is taxed as a corporation only if it has a preponderance of these characteristics. Generally, it has been held that if the entity has three or more of these characteristics, it is considered a corporation. If it has two or less, it is considered a partnership for tax purposes.

Under the current revenue rulings, the only corporate characteristics are limited liability and centralized management. The corporate characteristics of transferability of interest and continuity of life were not present. As discussed prior, since LLC's lack a preponderance of corporate characteristics, it is classified as a partnership.

Advantages of the LLC are numerous. Due to the classification as a partnership for tax purposes, the LLC can combine the corporate characteristics or limited liability for all investors with the income pass-through and special allocations of a partnership.

These special allocations are especially suited for real estate and oil and gas ventures. A distribution can be made to one member without distributing the same to other members. Additionally, distributions of property can be made without a step-up in basis that is normally attached to an S corporation.

A limited partnership must have at least one general partner who is personally liable for all debts and liabilities. The members of an LLC have no personal liability. However, as in the case of a corporate shareholder, members may be required to personally guarantee certain liabilities of the LLC.

S Corporations cannot have more than 35 shareholders nor can they own 80% or more of the stock of another corporation. Only individuals, estates and certain trusts may be shareholders of an S corporation. Nonresident aliens, corporations, and partnerships may not hold shares. In addition, S corporations can only have one class of stock.

None of these restrictions applies to the LLC. It can have more than 35 members, including any type of member. The LLC may own 100% of the stock of another corporation. Finally, as discussed prior, the LLC can provide for special allocations and distributions that would otherwise violate the S corporation of class of stock requirement.

The LLC is a tax and legal tool that, if used properly, can reduce the liability to certain individuals the risk of operating the business and allow certain tax advantages.

Grabau & Company, PC, is a certified public accounting firm established in 1990 and located in Denver, Colorado. Please contact our offices with any questions you have regarding the material in this brochure or if you would like further professional advice on the Limited Liability Company. Also, ask about our other brochures, including our S corporation information.