Roanoke Times
Copyright (c) 1995, Landmark Communications, Inc.
DATE: SUNDAY, April 23, 1995 TAG: 9504210065
SECTION: BUSINESS PAGE: F1 EDITION: METRO
SOURCE: MAG POFF STAFF WRITER
DATELINE: LENGTH: Long
No, it's not sex and only indirectly concerns money. The topic is the limited liability company, a relatively new way for two or more people to hold a small business or real estate venture.
Although it seems a dry and technical topic, in less than four years the new concept in business organization has had a significant impact on the way people are doing business and paying taxes on their profits.
There were 356 such outfits formed in Virginia in the 1992 fiscal year, the first time limited liability companies were established in the state. Since then, that number has risen sharply to 2,724 such filings with the State Corporation Commission through mid-April, less than 10 months into the current fiscal year. In all, there were 6,581 Virginia businesses chartered as limited liability companies as of April 12, the most recent count.
And the format should become even more popular considering that the Internal Revenue Service relaxed some technical rules in January, and the 1995 Virginia General Assembly also cleared up minor technical flaws. The state legislation takes effect July 1.
By definition, a limited liability company is a form of business organization that combines the liability protection of a corporation with the tax advantages of a partnership. Changes proposed earlier this month by the Internal Revenue Service would make it easier to set up an LLC. And the IRS will hold a public hearing July 20 on a still-unwritten rule that would eliminate a tax wrangle if there is a technical mistake in setting up the papers.
Yet when two Roanoke lawyers who have helped clients convert to the new form of business incorporation polled clients for a small-business person to discuss experiences with the new form of organization, they found nobody willing to talk publicly. One of the lawyers spent a half-day phoning an estimated 30 people.
Perhaps they feared being branded as tax avoiders, although even the government says you should pay no more taxes than you must. That's because there are some definite tax advantages for partners to switch to a limited liability corporation.
"I've formed bunches of them," said Nicholas C. Conte of the Roanoke law firm of Woods, Rogers & Hazlegrove. "I talk about it to clients all the time."
That can range from Valley Bank to the smallest business or real estate venture involving two people.
In 1991, Virginia became the seventh state to enact enabling legislation, said John M. Huddle of the Roanoke law firm of Gentry, Locke, Rakes & Moore. An IRS ruling in December 1992 made it "a bulletproof act," Huddle said, so that if you form an LLC you will qualify for favorable tax treatment.
since we're quoting another publication, is this comment worth a direct quote?
The impact is that two other popular forms of chartering companies - limited partnerships and Subchapter S corporations - are getting far less attention and use.
A limited liability company combines the advantages of a corporation with the favorable tax treatment of a partnership, Conte and Huddle said.
Stockholders of a corporation, they explained, enjoy freedom from personal legal liability for the actions of the company unless they are guilty of fraud or the like.
But most corporations, unless they are S-corporations, are taxed twice. Corporate profits are subject to taxation at the corporate level, and then are taxed again when paid out to the shareholders in the form of dividends.
Under a partnership arrangement, the profits and losses flow through to the partners and are thus taxed only once. The partners pay the tax one time and can use the tax advantage of any losses.
The partners, on the other hand, are personally liable for the actions of the partnership. Limited partnerships do exist, but the general partner is still liable, while the limited partners are barred from materially participating in management. In an LLC, the owners can manage jointly or elect managers.
By contrast, an LLC is a hybrid. It provides for flow-through of the profits or losses like a partnership. But, the owners also are free of personal liability for the LLC's debts, contracts and negligent acts.
Conte believes it will make an attractive alternative to Subchapter S corporations and may make some forms of partnerships obsolete. But "I don't think it's going to replace corporations. There are good reasons to have a corporation," Conte said.
For one, corporations, including Subchapter S corporations, can be owned by one person. LLCs are formed by two or more owners. For another, a corporation provides for free transfer of interest in the company by selling stock - an advantage for a large company, but perhaps not seen as a virtue for a small, closely held business.
Or LLCs may precede a corporation. For example, organizers of Valley Bank in Roanoke created an LLC in which to invest their initial funds. Its annual report to the Securities and Exchange Commission said they formed the "Organizational L.C." to provide for financing of organizational and other costs. It was created Jan. 6, 1994, prior to incorporation of a holding company, Valley Financial Corp., for the bank, and will be dissolved when the bank begins operations in May.
A. Wayne Lewis, senior vice president of Valley Bank, said an LLC was chosen because it offered the personal liability protection of a corporation and the tax advantages of a partnership. Had the venture collapsed in its early stages, he said, it would have been easier for the investors to handle their losses.
Another local example is a consortium of smaller banks, including Piedmont Bank of Martinsville and Bank of Buchanan, who pooled their resources through an LLC to finance low income housing under the Community Investment Act.
Huddle said "that deal couldn't have been done except through an LLC." That's because the goal was pass-through of low-income housing tax credits, but state banks may not invest in limited partnerships.
Conte said many of the LLCs that he has formed were created to hold real estate.
"It's a really simple and efficient entity to use" for real estate, he said, and it avoids double taxation of the proceeds when the land is sold. Operating losses can be passed through to the owners for their own tax returns.
It also protects commercial real estate investors in an era when lawsuits over fair housing complaints, Americans with Disabilities Act complaints and third-person assaults on tenants threaten the economic welfare of property owners.
He knows of a local business that had been incorporated while its building was held by the owners as a partnership for tax reasons. Now the entire entity is an LLC.
The main issue with owners in an LLC, Conte said, is the difficulty of transferring interests. An owner can pass on or sell his right to distributions from the business profits, but he must have approval of the other owners in order to sell his interest outright. This can, depending on how the organizational papers are drawn, range from 51 percent to 100 percent approval.
This makes an LLC most suitable for a closely held company, such as a small family business where members wouldn't want a black sheep selling an interest to outsiders. But, Conte said, a company with hundreds of shareholders would want the stock selling rights of a traditional corporation.
Huddle said that anyone who formed an LLC will qualify for favorable tax treatment because of an Internal Revenue Service revenue ruling in December 1992. That's the point at which formation of LLCs really took off, he said.
An LLC can be formed, Huddle said, by two or more individuals, corporations and trusts in any combination. That means an LLC lends itself to become a creative estate planning tool; "we are able to do some things beneficial for the client's estate planning through the use of an LLC instead of a trust."
He also knows of a multi-location business in which the owner wants a shield from liability but also a flow-through for tax purposes. In the past, he said, the company operated as a series of corporations, one for each location. Each of these locations now operate through a separate LLC.
Back in 1991 and 1992, Huddle said, people were cautious because Virginia was a pioneer in creating LLCs. There were questions about multistate transactions then, but today only three states - Hawaii, Massachusetts and Vermont - do not offer this form of business chartering.
And until last year, owners of membership interests in an LLC had to get approval of 100 percent of the other LLC members to allow a purchaser to become a member, Huddle said. Although it's still possible for the LLC to demand unanimous approval, only a majority vote is required, making it palatable to more people.
And until last year, owners of membership interests in an LLC had to get approval of 100 percent of the other LLC members to allow a purchaser of the interest to become a member in the LLC, Huddle said. Although it's still possible to draw the papers so as to demand unanimous approval, requiring only a majority vote to allow a transferee to become a full member makes the concept palatable to more people.
Another disadvantage is that it is more difficult to shelter retirement income compared to a corporation. Huddle said that 401(k) limitations imposed on entities like LLCs that are taxed as partnerships are different than corporations, limiting the dollars that can be set aside.
But Huddle said these same considerations affect corporations and partnerships.
Huddle said he handles "a fair number" of requests to set up a small business venture. "In more and more situations," Huddle said, "I recommend the LLC as the entity of choice."
by CNB