Structure strategies Featured

9:55am EDT July 22, 2002

2nd in a 2-part series

As discussed last month, the annual business structure review is the most effective way to continue working toward your goals and get the best possible tax advantages for your business. This month, I’ll look at the last two most common business structures, general partnerships and Limited Liability Companies (LLC).

The main benefit for general partnerships is simplicity. However, general partnerships, which are easily established for any business, may not always be the best choice even though there are tax advantages. Partners do not pay federal taxes at the partnership level. Instead, income and expenses are divided among the partners according to their ownership percentage. Each partner pays taxes on his or her share of the partnership profits (whether distributed or not) based on his or her individual tax rate.

In this respect, general partnerships offer considerable flexibility in allocating economic benefits among partners. The disadvantage with general partnerships concerns liability. The partners in a general partnership are personally liable for any losses the business incurs.

Even worse is the fact that, if a partnership gets in financial trouble or has a liability lawsuit placed against it, one partner who is wealthier than the others can be liable for amounts greater than his ownership percentage of the business. In other words, creditors or plaintiffs will come after the partner with the money.

Limited Liability Companies (LLCs), which are hybrids of corporations and partnerships that attempt to combine the most favorable characteristics of each, share the same tax benefits as general partnerships. However, LLCs protect their members from personal liability for business debts and liability lawsuits. Only the members’ investments are at risk.

Given this clear advantage of liability, protection and favorable taxation, the question is, why don’t more business owners register their businesses as LLCs rather than general partnerships? One answer is the complexity. Each state has different laws concerning the formation of LLCs. Some even allow partners in general partnerships to have limited liability protection if they register as a “partnership having limited liability” or Limited Partnership.

However, LLCs do benefit families with many businesses. Multiple family businesses can consolidate under one LLC, allowing family members to share equitably in both growth and income from all of the assets. Also, any member of an LLC can be involved in management without fear of personal liability. This is appealing for many senior family members in a business.

In addition, LLCs offer certain tax benefits other than those already mentioned. To a limited extent, losses generated from the business can be passed through to the personal returns of the members.

LLCs also offer entrepreneurs who own real estate a way to avoid probate. Since an interest in an LLC is considered personal property, forming a business as an LLC provides a way to “convert” the real property (i.e. real estate) into personal property, which avoids probate laws in the state where the real property lies.

There are, however, some disadvantages to LLCs. In addition to lack of uniformity in state laws, certain nontaxable fringe benefits, such as medical benefits, cafeteria plan benefits, meals, lodging, etc., are considered income for the members because they are not employees. Businesses currently formed as corporations cannot be converted to LLCs without taxable liquidations.

Also, if the owner retains too much control, the income and/or assets could be considered a part of his estate. Louis P. Stanasolovich is founder and president of Legend Financial Advisors, Inc., a fee-only Securities and Exchange Commission registered investment advisory firm located in the North Hills that provides asset management and comprehensive financial planning services to individuals and businesses. Reach him at (412) 635-9210. The firm’s Web site is www.legend-financial.com.