Limited Liability Company, Limited Partnership, and C Corporation

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Limited Liability Company (LLC)

Under the laws of the majority of United States jurisdictions, a limited liability company (LLC) is a legal form of business enterprise that provides limited liability to its owners. Unlike more common "C" and "S" corporations, investors or owners of LLCs are called members, not stockholders or partners (partnerships), and their investments are called membership interests and units, not shares (stock).

LLCs can be formed quickly and inexpensively, and are not taxed as entities in most states. It is important to be sure that the LLC operating agreement contains the language necessary for the LLC to receive pass-through tax status like a partnership, and for that reason alone, the operating agreement should be formulated by an attorney familiar with state and federal laws regarding LLCs.

Currently, LLCs are the most popular vehicle for use with IRA investors, as they provide asset protection for members, including IRAs, and because they are not taxed at the corporate level. This allows profits to flow through to IRAs as either tax-deferred or tax-free with Roth IRAs.

An LLC should be formed in the state where investments are made to avoid additional costs of filing in both the state of domicile and the states where the LLC is doing business as an investor.

Limited Partnership (LP)

A limited partnership is a form of partnership similar to a general partnership, except that in addition to one or more general partners (GPs), there are one or more limited partners (LPs). It is a partnership in which only one partner is required to be a general partner.

The general partners are, in all major respects, in the same legal position as partners in a conventional firm, i.e. they have management control, share the right to use partnership property, share the profits of the firm in predefined proportions, and have joint liability for the debts of the partnership.

Like shareholders in a corporation, LPs have limited liability, meaning they are only liable on debts incurred by the firm to the extent of their registered investment and have no management authority. The GPs pay the LPs a return on their investment (similar to a dividend), the nature and extent of which is usually defined in the partnership agreement. General Partners thus carry more liability, and in cases of financial misfortune, the GP becomes "the generous partner."

Limited partnerships are distinct from limited liability partnerships, in which all partners have limited liability.

Limited partnerships are less common today with the growing popularity of the LLC. While they can have the same passive income flow-through characteristic of an LLC as well as excellent asset protection capabilities, they can be more expensive to form and maintain due to their complexity.

C Corporation

A C corporation refers to any corporation that, under U.S. income tax law, is taxed separately from its owners. Most major companies (and many smaller companies) are treated as C corporations for U.S. income tax purposes.

Almost all companies that aspire to become very large companies will use the C corporate structure, which is the most flexible while offering the same advantages of the other structures (e.g., asset protection), with one exception—are taxed at the corporate level. The result for an IRA investor is that before dividends or other profits are distributed to the IRA, they are taxed, reducing the benefit to the IRA.

Any distribution from the earnings and profits of C corporations is treated as a dividend for U.S. tax purposes. Earnings and profits are a tax concept similar to retained earnings. Exceptions apply to treat certain distributions as made in exchange for stock rather than as dividends. Such exceptions include distributions in complete termination of a shareholder's interest and distributions in liquidation of the corporation.

C vs. S Corporation

Shareholders of a corporation may elect to treat the corporation as a flow-through entity known as an S corporation. An S corporation is not itself subject to income tax; rather, shareholders of the S corporation are subject to tax on their pro rata shares of income based on their shareholdings. S Corporations may not have IRAs as shareholders, however, it is possible for an IRA to lend money to an S corporation.

To qualify to make the S corporation election, the corporation's shares must be held by resident or citizen individuals or certain qualifying trusts. Unlike corporations treated as S corporations, a corporation may qualify as a C corporation without regard to any limit on the number of shareholders, foreign or domestic.

Potential for Unrelated Business Income Tax (UBIT) or Unrelated Debt Financed Income (UDFI)

Operating companies, that is trades or businesses organized as LLCs or LPs, present the potential for Unrelated Business Income Tax (UBIT) and should only be considered under the advice of a qualified tax professional.

Additionally, if an LLC or LP borrows money to conduct business, the potential for Unrelated Debt Financing Income Liability Tax (UDFI) may exist and should be considered under the advice of a qualified tax professional.