The Misunderstood Limited Liability Company?

Rick Dillon

Limited liability companies (LLCs) were not just a fad of the nineties; they were merely misunderstood and misused. When the LLC was created in the late 80’s, I saw them as nothing more than additional revenue sources for lawyers. Instead of incorporating a new business for $500 to $1,000, attorneys began charging $1,500 to $3,000 just to set-up the entity. Hindsight tells me however, there were many attorneys who set-up LLCs with the best of intentions to give clients tremendous flexibility for the future. The problem has been that the entrepreneurs didn’t know what, how or when to use that new flexibility. However, in many of those cases the impact of a (partnership style) LLC versus an S corporation had a harmful impact on annual tax burdens.

Back in the mid-to-late 80’s, LLCs became the hot new thing. The biggest exposure seemed to be the potential threat that these new and unproven entities would be challenged in court, especially across state lines where other states didn’t have LLCs.

John, a pallet & custom crate-manufacturing client of mine, had been set-up as an LLC in the 80’s. John could have been an S corporation over the last 15 years and saved more than $75,000 in employment taxes and social security costs. This is one of the problem with LLCs. They are misunderstood and in many cases, they are square pegs that were shoved in round holes.

Limited liability companies (LLC) are now recognized in all 50 states. To look at the original purpose of the LLC, we must first look at the purpose for incorporating. The corporation or "corporate shells" main purpose is to help separate an owner’s personal identity from that of his or her business. Sole proprietors and partners are subject to unlimited personal liability. Creditors of the sole proprietorship or partnership that sue the business are in effect suing the owners as well. With a judgment in hand, the creditor can then move to seize the owners’ homes, cars, savings or other personal assets. Once incorporated, the shareholders of a corporation risk loosing only their investment and usually no more.

With a little research on the Internet, you will find conflicting opinions to the advantages and disadvantages of the LLC. One site claims LLCs are more complicated and require more paperwork; while the next site suggests they are easier to administrate because annual meetings and minutes are not required. These are not reasons to pick one entity type over another. The most important concept an owner should take from John’s situation described earlier is … don’t accept any professional advice until you understand what, when, why, where and how to use it.

The tax and legal world we live in is so enormous and complex it requires a team of advisors to get the best results. The tax code is like a 10,000-piece puzzle. You may choose to construct your puzzle using only eight to 10 of the pieces, but your tax picture will be very simple and costly. On the other hand, taking the time and expense to use all 10,000 pieces of the puzzle will be similarly dysfunctional. An owner must find balance between simplicity and cost effectiveness.

Education, Communication, & Planning
Start all of your planning with the concept that every person on the team is probably not up to speed on the necessary subject matters. Then very clearly review your personal and corporate goals with the team. The last step before planning is to dissect everything into basic elements (puzzle pieces), and then begin constructing the plan (the puzzle). In the information age we live in, it is impossible to stay up on all the options. What amazes me is there are still some old school advisors that will offer opinions when they haven't kept current or the subject matter is outside their expertise. Don't fall into the trap of assuming your advisors are different from this. They may be different, but like due diligence on a transaction trust but verify.

To help you with your education process here are some of the elements of an LLC:

Limited Liability

Flexible Management Structure

• LLCs do not need to hold annual meeting of shareholders and directors nor are they required to keep annual meeting minutes like those required in the C and S corps.
• LLCs are simply run by the members and/or managers.
  

Flexible Ownership is Permitted

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