Today we’re going to discuss Limited Liability Company basics. So, first of all, why are LLCs so popular?
Well, there’s a few different reasons but one of the reasons is you can choose, depending on how you set it up, you can choose an LLC to be taxed one of four ways. It can be taxed like a partnership. It can be taxed like a disregarded entity or it can be taxed like a C or and S corporation.
Now, just so you know I’m going to explain the term disregarded entity. A disregarded entity is an LLC or other entity set up so that its activities are treated directly as activities as if they were done by you but only for tax purposes.
For asset protection purposes, it’s still a separate legal entity but for tax purposes you and the LLC are treated as one and the same. So, what that means is that for example, normally an LLC cannot hold an S corporation stock but if the LLC is a disregarded entity, it can hold S corporation stock without the S corporation becoming disqualified.
A partnership disregarded entity and S corporation tax status those are all what we call pass through taxation meaning that the members of the LLC pay taxes for the LLC instead of the LLC itself. But you can have your LLC file a form with the IRS.
It’s form 8832 and it can be taxed like a C corporation and then the LLC pays its own taxes sometimes at a lower tax rate than you would normally pay and only if or when distributions are made to you would you pay an extra tax.
Sometimes people don’t like the C corporation tax treatment because you would be paying taxes twice once the LLC tax is a C corp pays its own taxes and it’s paid again when profits are distributed to you. But there’s all sorts of tricks you can do to sometimes legally get around that.
Sometimes you want to start up a company and then just grow the capital inside the company and use profits to grow the company and in that case C corporation tax treatment may be better if you end up being taxed at a lower tax rate the LLC as a C corp then you would pay if you are paying taxes.
An LLC tax as an S corporation, that is oftentimes used for self-employed people to reduce self-employment tax which is a tax of 15.3% on your first $106,000 or so of income and that’s paid in addition to your income taxes. So, a lot of times your LLC can file form 2553.
It can elect to be treated as an S corporation for tax purposes even though it’s still legally an LLC. You may save $5,000, $6,000, $7,000 a year up to that amount using this certain strategy with an S corporation. And even if you make more than $106,000 a year, you still pay self-employment tax of 2.9% instead of 15.3%. So, S corporation treatment may still be a good way to go.
A partnership treatment is often used for holding real estate and I am grossly oversimplifying things or in circumstances where you are a member of the LLC but you’re not a managing member, you may be able to say not pay self-employment taxes on any of your profits with a partnership treatment. So, depending on what you’re doing with an LLC, you can pick your poison how the entity is going to be taxed.
The partnership can only be taxed as a partnership. You can’t get the benefits of S corporation taxation if that’s more appropriate for you.
A corporation may only be taxed as a C or S corporation but not as a disregarded entity or a partnership so the LLC has flexibility according to what you’re doing. It can pick the best tax election for the best tax savings for you.
Now, let’s talk about limited liability traits. What does limited liability mean? Well, most people when they think limited liability, they’re talking about how you will not be held personally responsible for business debts. Now, it’s not only business debts but it can mean in some situations your business sues you and in certain – I’m sorry, sues your LLC and in certain situations especially if you don’t manage that LLC, they’re not going to be able to sue you personally. They just sue the company and they can only get what’s inside the company.
That’s known as inside liability. That’s when someone sues your LLC directly because they have a reason to sue your LLC. The LLC is suspected of some type of breach of contract or some other business deal gone sour or something like that. They then sue the LLC directly.
Now, there’s another type of limited liability and this is used most for asset protection, both types are really asset protection but charging order protection is a special trait that limited partnerships, that’s an LP, and LLCs also benefit from. And what charging order protection is if you’re an owner which is called a member of an LLC and someone is suing you and they want to get assets inside your LLC, they generally cannot do that if your LLC is set up correctly, same thing with a limited partnership.
You get the best of both worlds because a limited partnership does not get limited liability against inside threats although it does get charging order protection.
So, an LLC gets the protection that corporations have which is limited liability against these inside threats but it gets a charging order protection that a limited partnership gets and that’s the type of protection that corporations don’t get.
So, in other words, with an LLC you get both types of protection. You get – protection gets inside and outside threats which is something that LPs by themselves don’t get for all members not for the general partners especially and corporations don’t get protection against outside threats.
Anyone can seize their corporate interest and if they get a majority of voting stock in a corporation, they just vote to liquidate everything and then they get all the assets inside while with an LP or LLC you can’t do that with this charging order protection. So, you really do get the best of both worlds.
Now, another thing we need to discuss – by the way, we do discuss charging order protection fairly in depth, at least we discussed, thoroughly discussed the fundamentals in another free video that is on this website. The next thing we’re going to discuss are what are corporate formalities.
Well, in order for a corporation or a limited partnership or LLC or limited liability partnership to have its limited liability, there are some things you have to observe. You need to treat it as a business, your business entity and you need to treat each affair as being separate from your affairs.
The good news with an LLC is it’s not as complicated to manage an LLC as it is with the corporation. A corporation you need to have what’s called a three-tiered management structure.
That means the shareholders are in charge of appointing the Board and the Chairman of the Board and all that and then the board members have to approve certain strategic decisions made by the corporate officers which the run the everyday business of the corporation. That’s your CEO, your president, secretary, treasurer, etc.
So, you constantly have to draft these resolutions where board members are approving the CEO or other officers to do things and you have to, you know, at certain times you have stockholder meetings. You have to have annual meetings with the corporation. Well with an LLC, the management of an LLC is pretty informal.
They all see managers most of the time. They just do what needs to be done without needing approval from anyone else. There are narrow circumstances where the owners of an LLC will need to approve things but it’s very narrow most of the time.
The LLC managers just go about their business so all this cumbersome red tape, bureaucracy, three-tiered management structure, you can skip through a lot of that with an LLC and it’s generally viewed as an entity that’s a lot easier to use a corporation.
However, it’s still a good idea to observe some requirements even though the LLC law in your particular State may not spell out that you have to do this. It’s generally a good idea to have at least an annual meeting where all the members and managers meet together and discuss certain business topics.
You do want to keep the business affair separate from your personal affairs. If you mingle those together and you’re using your LLC bank account to pay for your personal growth trees or things like that, if you’re not keeping separate books and records, have a separate mailing address for your LLC for example, then a judge may decide to disregard that limited liability that your business entity normally gets and that’s not good because you would lose your asset protection.
So, that concludes today’s video on LLC basics and I hope you’ve enjoyed this and found this useful. Thank you.