Business Law 101 / Benefits of LLCs

By Albert L Kelley, Esq.

Last week I covered the tax benefits of an S corporation over a C Corporation. I ended the column by advising that if a shareholder get sued personally, their stock in a company can be seized by their creditor, regardless of what type of corporation they have. For many businesses, like a personal services corporation, this is not a major issue as the stock has no value without the particular shareholder who owns it. But for businesses such as restaurants or retail stores where the company has value on its own merits, a judgment can result in the shareholder losing their business. In order to get around this issue, in 1982 the Florida legislature created the first Limited Liability Company Act. Under the concept of a limited liability company, the owners would not hold shares in a company but rather membership in an organization. This meant that the ownership interest was protected from judgment creditor. Just as a judgment creditor could not take away your membership in Rotary or The Women’s Club, they could not take your membership in an LLC. But this new business entity form created tax questions with the IRS.

How should an LLC be taxed? The IRS ultimately determined that the owners of an LLC could choose how to be taxed.  They can choose to be taxed as a corporation (either C or S) or they can be treated as a disregarded entity where the IRS would ignore the LLC entirely. Any member or members would be personally responsible for the taxes (in fact, for a single member LLC choosing to be taxed as a disregarded entity, the LLC does not even need to file a tax return as all income and expense reported on the member’s personal tax return). By default, a single member limited liability company will be treated like a sole proprietorship by the IRS; a multimember limited liability company will be treated like a partnership. So essentially, you receive the income tax benefits of an S corporation with none of the shareholder liability. In addition, you’re not limited to the restrictions of the subchapter S corporation; i.e. the number of owners is not restricted and the owners do not need to be natural people or US citizens. This allows ownership in an LLC to be held by foreigners and allows the LLC to have subsidiaries.

Now there are two caveats to this. First is the shareholder liability. In 2012 a judge in Florida determined that a single member LLC was no different than a single member shareholder corporation and for the first time allowed a judgment creditor to seize ownership of a limited liability company. This ruling created controversy throughout the state and was finally addressed by the legislature who crafted a law that essentially states a judgment creditor may not seize the ownership of a limited liability company if the owner can show they will be able to pay off the judgment within a reasonable period of time through the dividends they receive from the company.

The second issue is an increase in tax benefits. Because the IRS allows the owners to determine how they will be taxed, there are additional tax issues to consider. Generally, in a sole proprietorship, partnership, or disregarded entity LLC, all pass-through income is taxed for FICA (self-employment or Social Security tax). However for LLCs that elect to be taxed like a corporation but then select the subchapter S election, FICA is only charged on the portion of income paid as salary to the owners. In other words, the remaining pass-through money is not subject to this additional tax. If the owner pays themselves a small salary and take the rest of the dividends, they can greatly reduce the tax obligation. These are complicated issues and any businessperson debating what entity to form should consult with their attorney and their accountant to make the selection that works best for them.

Al Kelley is a Florida business law attorney located in Key West and previously taught business law, personnel law and labor law at St. Leo University.  He is also the author of “Basics of Business Law” “Basics of Florida’s Small Claims Court” and “Basics of Florida’s Landlord-Tenant Law” (Absolutely Amazing e-Books). This article is being offered as a public service and is not intended to provide specific legal advice.  If you have any questions about legal issues, you should confer with a licensed Florida attorney.

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