LLC Law and Tax

Set forth below is an introduction to LLC law and tax, with basic comparisons between LLCs, corporations and general partnerships. The points below are based on attorney John Cunningham’s book entitled Drafting Limited Liability Company Operating Agreements, published by Wolters Kluwer Law & Business. Drafting Limited Liability Company Operating Agreements is the leading LLC formbook and practice manual. John is a recognized scholar and practitioner in the fields of both LLC law and tax and section 199A.

  1. LLCs are statutory business entities. This means that they are formed under state law and are legal persons that exist independently of their owners, they own their property in their own name and they can act in their own name.
  2. LLC business asset protections. LLCs can provide their owners (called “members”) with three types of statutory business asset protections:
    1. Liability shields. LLCs provide their members with statutory liability shields. These shields protect members from claims by third parties relating to the member’s business unless these claims arise from the members’ personal negligence or other personal misconduct.
    2. 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 right to these creditors. Management rights are rights relating to the control of LLCs, including contract-signing rights, business decision-making rights, voting rights, information rights and dispute resolution rights.
    3. Charging order protections. LLCs provide their members with protections under statutory “charging order” provisions. Under some LLC statutes (including the Delaware Limited Liability Company Act), these provisions provide that the only remedies available to creditors of members with regard to the members’ LLCs is the right to receive distributions of LLC profits that would otherwise go to the members.
  3. Business asset protections—multi-member LLCs vs. single-member LLCs. However, under most LLC acts, statutory LLC liability shields are much stronger for members of multi-member LLCs than members of single-member LLCs; as indicated, pick-your-partner protections are unavailable to members of single-member LLCs; and charging order protections are also unavailable to members of single-member LLCs.
  4. LLCs vs. corporations and general partnerships.
    1. Like LLCs, corporations and limited liability partnerships provide their owners with limited liability.
    2. Corporations don’t provide their shareholders with pick-your-partner or charging order protections. General partnerships do provide these protections.
    3. 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.
    4. LLCs have the same tax flexibility as general partnerships, but far greater tax flexibility than corporations.
  5. LLC tax.
    1. Single-member LLCs owned by individuals can be subject to federal income tax either as sole proprietorships or as S corporations. If they are taxable as sole proprietors, this may enable them to save significant Federal income taxes but may increase their liability for Social Security Taxes.
    2. Multi-member LLCs are generally subject to federal income taxation either as partnerships or as S corporations. Choosing between these two federal tax regimens can be complex, since, among other considerations, members must weight their federal income tax liabilities against their Social Security Tax liabilities.

However, it is critical to all members of start-up and existing LLCs to maximize the extraordinary section 199A deductions available to them as LLC members. These deductions can arguably exceed 20 percent of their business income. In other words, LLC issues and section 199A expertise are inseparable, and they strongly support each other. Thus, in order to provide efficient and comprehensive service to their clients, LLC lawyers should also be experts in section 199A law.

Attorney John Cunningham has extensive experience in representing not only LLC clients but also section 199A clients, and he is the author of Maximizing Pass-Through Deductions Under Internal Revenue Code Section 199A—a Section 199A Practice Manual, the only book on section 199A published by a recognized legal and tax publisher. His LLC practice and his section 199A practice are interdependent, and they strongly support one another. He provides free initial consultations regarding both LLC law and tax and section 199A. His telephone number is 603.856.7172.