LLC Law and Tax

What is the most suitable setup for your business? The following introduction to LLC law and tax—with basic comparisons between LLCs, corporations and general partnerships—is based on attorney John Cunningham’s book, Drafting Limited Liability Company Operating Agreements, the leading LLC formbook and practice manual.

Overview of LLCs

LLCs: statutory business entities

LLCs are formed under state law and are legal persons that exist independently of their owners. LLCs own their property in their own name and can act in their own name.

LLC business asset protections

LLCs can provide their owners (called “members”) with three types of statutory business asset protections:

  • Liability shields. LLCs provide their members with statutory liability shields, which protect members from third-party claims relating to the members’ business unless these claims arise from the members’ personal negligence or other personal misconduct.
  • Pick-your-partner protections. LLCs provide members of multi-member LLCs (but not members of single-member LLCs) with “pick-your-partner” protections. These protections prevent members’ creditors from obtaining judicial orders transferring members’ management rights to these creditors. Management rights relate to the control of LLCs, including contract-signing rights, business decision-making rights, voting rights, information rights, and dispute resolution rights.
  • Charging order protections. LLCs provide their members with protections under statutory “charging order” provisions. Under a number of LLC statutes (including the Delaware and New Hampshire acts), these provisions provide that the only remedies available to creditors of members with regard to the members’ LLC is the right to receive distributions of LLC profits that would otherwise go to the members.

Business asset protections: multi-member LLCs vs. single-member LLCs

Under most LLC acts, statutory LLC liability shields are much stronger for members of multi-member LLCs than for members of single-member LLCs. Under these acts, pick-your-partner protections and charging order protections are unavailable to members of single-member LLCs.

LLCs vs. corporations and general partnerships

  • Like LLCs, corporations and limited liability partnerships provide their owners with limited liability.
  • Corporations don’t provide their shareholders with pick-your-partner or charging order protections. General partnerships do provide these protections.
  • LLCs provide their members with far greater legal flexibility than corporations in tailoring their companies to meet member needs and interests. General partnerships are also very flexible.
  • LLCs have the same tax flexibility as general partnerships but have far greater tax flexibility than corporations.

LLC tax considerations

  • Single-member LLCs owned by individuals can be subject to federal income tax either as sole proprietorships or as C or S corporations. If they are taxable as sole proprietors, this may enable them to save significant federal income tax but may increase their liability for Social Security taxes.
  • Multi-member LLCs are generally subject to federal income taxation either as partnerships or as S corporations. (Subchapter C is typically not a good option for these LLCs.) Choosing between these two federal tax regimens can be complex, since, among other considerations, members must weigh their federal income tax liabilities against their Social Security tax liabilities.

LLCs and section 199A tax benefits

All members of start-up and existing LLCs should maximize the extraordinary section 199A tax deductions that will be available to them as LLC members if their LLC is properly structured. These deductions can exceed 20 percent of their business income. To provide efficient and comprehensive service to their clients, LLC lawyers also should be experts in section 199A law.

Attorney John Cunningham has extensive experience in representing LLC clients and section 199A clients and is the author of Maximizing Pass-Through Deductions Under Internal Revenue Code Section 199A. He provides free initial consultations on LLC law and tax as well as on section 199A.