Ronald J. Cappuccio, J.D., LL.M.(Tax) Counsellor at Law	1800 Chapel Avenue West Suite 128 Cherry Hill, New Jersey 08002 USA (856) 665-2121 Fax (856) 665-9005 E-mail: Ron@TaxEsq.com

Limited Liability Companies versus Other Entities

General Concepts

1. The LLC is a Separate Legal Entity. The problem of sole proprietors co-mingling business assets and income with personal assets and income is lessened with an LLC. The sole member LLC will definitely have its own Federal Tax ID Number, its own bank accounts, and machinery and equipment titled in its name.
2. Limited Liability for All Members. The partnership has no limits to liability for the partners. A limited partnership limits liability for the limited partners if they do not materially participate in the business. Similar to a corporation, Limited Liability Companies permit every member to have limited liability.
3. Combined Advantage. A Limited Liability Company has the combined advantage of limited liability for all of the members and the tax advantage of being treated as a partnership (the pass-through entity with maximum flexibility in contrast to an "S" corporation).

Limited Liability Companies Compared to "C" Corporations.

1. Liability Protection. "C" Corporations and Limited Liability Companies provide similar protection of the personal assets of the shareholder/members.
2. "C" Corporations Are Not a Pass-Through Entity. Whereas, Limited Liability Companies are generally a pass-through entity and treated as a partnership for tax purposes.
3. Double Taxation. The "C" Corporation is subject to double taxation at both the corporate level and upon distribution to shareholders. A Limited Liability Company treated as a partnership has one level of taxation.
4. Phantom Income. "C" Corporations can accumulate earnings paying tax at the corporate level without the shareholders being individually taxed. The LLC, on the other hand, if it attempts to accumulate earnings, could make the shareholders subject to "phantom" income, therefore being taxed on income not earned. The "phantom income" issue is a simple concept. "Phantom income" arises where the shareholder has income for tax purposes and no money received from the LLC to pay for those taxes. If the Limited Liability Company earns income and then uses that income to purchase a capital good, the result is phantom income to the members. For example, if the LLC earns $100,000, and purchases a machine for $100,000, in the same year, the LLC has no income to distribute to the members. Nevertheless, the individual members are taxed on that $100,000 (minus the depreciation pass-through to the members) without receiving any money to pay those taxes. Other examples include where one group of members lends money to the LLC and then expects to be paid back at a rapid rate. The amount of money paid back to the member, which constitutes loan principal, is not deducted by the LLC and is subject to income tax for the members.
5. Retirement Plan Differences. LLC members who are treated as partners and own more than 10% membership interest cannot borrow against a qualified retirement plan account pursuant to IRC Section 4975. (This is similar to the "S" Corporation Shareholder who owns more than 5% of the corporation who is also prevented from borrowing against the qualified retirement plan account.) On the other hand, the "C" Corporation Shareholder/Employee can borrow against their qualified retirement plan.
6. Limited Number of Members. LLCs, although legally not limited to a particular number of members, are practically limited by Internal Revenue Code. IRC 7704 provides that if LLC membership interests are "widely held", they are treated as "publicly traded." If the LLC is considered "publicly traded", then the LLC will be treated as a "C" Corporation for Federal Income Tax purposes.

Limited Liability Companies Compared to "S" Corporations.

1. Limitation of Liability. Both the LLC and the "S" Corporation provide similar limits on liability.
2. Pass-Through Entities. Even though an "S" Corporation and an LLC treated as a partnership are both "pass-through entities", there are many restrictions that apply to an "S" Corporation that do not apply to LLCs. These "S" Corporation restrictions include a limitation of 75 shareholders, the fact that shareholders can only be individuals, estates, and some trusts, and there can only be one class of stock. This greatly limits the "S" Corporation as an entity for transferring interest between generations. Other restrictions include prohibitions agreement. Corporation electing "S" status if it is not a domestic corporation.
3. Limitation on "S" Corporation Deductions. "S" Corporation shareholders can deduct losses only to the extent of their basis in stock plus the amount of any debt for shareholder loans made to the "S" Corporation. (See IRC Section 1366). Even if the "S" Corporation Shareholder personally guarantees the corporation's debt, as is the typical creditor's requirement for most newly formed "S" Corporations, losses cannot be deducted on that debt. In contrast, LLC members are treated as partners for tax purposes and obtain additional basis in their LLC membership interest for their allocated share of LLC debts. This could result in increased deductions for LLC members compared to "S" Corporation members.
4. Foreign Members. The LLC may have different tax treatment for foreign members than a partnership/corporation in their home country. Also, foreign business associates may not be familiar with the Limited Liability Company as a business entity.

Limited Liability Companies Compared to General Partnerships

1. Limited Liability. LLCs have limited liability. General partnerships do not.
2. Control. Each general partner has the power to act as an agent of the partnership and enter into contracts that are legally binding on the partnership. Limited Liability Companies act through managers who are able to legally bind the LLC.
3. Professional Service Liability. Even though the partner and Limited Liability Company member are both liable for their own personal malpractice and other personal tortious acts, the Limited Liability Company can protect LLC members against non-professional liability for actions by other members.
4. Taxation. Generally, the Limited Liability Company and the partnership are taxed the same for Federal Tax purposes.

Limited Liability Companies Compared to Limited Partnerships.

1. Liability. All members of the Limited Liability Company are protected. In a Limited Partnership, at least one general partner has unlimited exposure to liabilities of the partnership. A Limited Partnership, in order eliminate liability, is required to set up a corporation, usually taxed as an "S" Corporation pass through entity, as the general partner.
2. Tax Consequences. A Limited Liability Company and Limited Partnership are generally taxed the same for Federal Tax purposes.
3. Limited Liability Company members can actively participate in the business without losing the limited liability. Limited partners can lose their limited liability protection if they are actively involved in managing the Limited Partnership.

Single Member Limited Liability Companies Compared to Sole Proprietorships and Corporations.

1. Limited Liability. Single Member LLCs have the same liability limitation as an "S" Corporation. In comparison, personal assets of the sole proprietor are fully exposed to liability for business actions.
2. Income Tax Savings. Amounts retained by an "S" Corporation and then distributed to the shareholder are not subject to FICA. This presumes that a "reasonable" wage is paid to the "S" Corporation shareholder. The LLC and sole proprietorship, because they are 1040 Schedule "C" filers pay self-employment tax on the full amount of the Schedule "C" net income.

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