Many owners of new and existing closely held companies are selecting a Limited Liability Company as the legal entity to conduct their business and investment operations.

The following information will assist you in the selection or change of the legal form of your business. It discusses both the Limited Liability Company (LLC) and the Limited Liability Partnership(LLP), and summarizes the essential income tax information for you in considering the use of the LLC or LLP entity status.

Federal, state and local commercial business laws affecting LLC's should be reviewed with legal counsel. We will use the term "LLC" in this discussion unless specific material differences relate to LLP's.

DESCRIPTION OF LIMITED LIABILITY COMPANY

An LLC is an unincorporated entity that combines the attributes of a partnership with the limited liability characteristics of a corporation. The personal assets of an owner (member) of an LLC are shielded from the liabilities and claims of the business entity. Individuals, corporations, pensions, trusts and even non-resident aliens can be members of an LLC. There is no limitation on the number of members an LLC may have.

Any business venture may use an LLC as its legal entity. However, an LLP designation is required to be used by those who are licensed professionals, such as doctors, lawyers, accountants, engineers and architects. Thus, while all professionals continue to remain personally liable for their own negligence, they are relieved from personal liability due to acts which they are not directly involved or associated with.

Nevertheless, all of the assets of the LLP entity are fully subject to all creditor claims. All fifty states and the District of Columbia now recognize LLC's. However, there are variations among the laws of each state. Until a uniform set of rules is agreed upon on a national basis, care must be taken by LLC's engaged directly or indirectly in multi-state operations. New York's law is among the most progressive in the nation.

BACKGROUND - OTHER ALTERNATIVE OWNERSHIP STRUCTURES

The appeal of the LLC entity for commercial enterprises, is (1) to obtain the benefit of limited liability treatment and (2) generally, to limit the income tax on a business entity to a one time tax only, payable at the individual owner level.

Prior to the introduction of the LLC laws, limited partnerships or S corporations were created to limit their owners' personal liability for the debts of the business entity and limit income taxation to a once-taxed basis. However, limited partnership entities have elements of personal risk in that at least one partner (the general partner) is exposed to unlimited liability. The advantages of a limited partnership, however, as in the case of general partnerships, include excellent flexibility in allocating income and deductions among its owners and afforded ease in transferability of ownership interests. General partnerships have no limited liability protections for any of its partners.

The use of the S corporation provides personal liability shelter to its shareholders from corporate creditors, but at a loss of flexibility in allocating income to its owners. Further difficulties may be caused by (1) limits on the number and type of shareholders; (2) possible unexpected or deliberate termination of S corporation status by: (i) acts of the shareholders; (ii) due to a prohibited activity by the corporation in certain equity or loan transactions; or (iii) due to certain changes in the nature of the S corporation's business operations. Consequently, the difficulties which can arise from Limited and General partnerships and S corporation ownership can now be overcome by the use of an LLC, resulting in a very attractive alternative tax entity under appropriate conditions.

INCOME TAXATION

Generally, an LLC does not pay income taxes directly to the federal, state and local governments (although in New York City the LLC may be subject to the NYC Unincorporated Business Tax). Instead, each member includes in his or her individual tax return, a prorata share (based upon the members' agreement) of each separate item of income, loss, deduction or credit of the LLC. Most states follow the federal rules for taxation of an LLC, but local tax statutes should be carefully reviewed. In addition, both New York and New Jersey impose filing fees based upon the number of members of an LLC or LLP.

The income tax classification (i.e. partnership or corporation) and resulting method of taxation is determined by the new "Check the Box" regulations. These regulations establish certain default classifications for LLC's and LLP's. Generally, an LLC with two or more members is classified as a partnership for income tax purposes. A single member LLC is treated as a sole proprietorship under the default provision. A filing of Form 8832 to choose a tax classification is only required if you elect a classification other than the default classification.

Income tax is payable only once on the earnings of the LLC. Income of the LLC is includible in the member's tax year within which the LLC's tax year ends. The LLC's earnings may be distributed to its members in the current or any subsequent year, in whole or in part, without any additional tax impact.

Virtually any business can benefit from the LLC format. Consequently, many thousands of LLC's will be formed in the coming years. The LLC offers business persons an excellent opportunity to protect personal assets from adverse business situations and provides great flexibility in dealing with income and equity changes as each entity grows and matures. The use of LLC's also create important opportunities for beneficial estate tax planning as well.

If you have questions about LLC's, or you would like to receive our comprehensive memorandum covering the advantages and disadvantages of Limited Liability Companies,