Business Structures - Limited Liability

By: Mike Gallagher, District Director
North Dakota District Office

Let’s talk about hybrids. No, not the cars, but the business structures that blend corporate and partnership attributes. Generally a choice of one business structure over the other is based on tax and/or liability considerations. Certain industries may have more risk than others, and each individual business owner may have different tax situations that have to be considered. This can be a complex process, and most often business owners are advised to seek professional counsel through a CPA and/or attorney. Please keep in mind that not all attorneys may a background in tax or have access to tax advisers and that CPAs may not be in a good position to provide the proper counsel regarding liability. Also it’s good to know that many liability issues are covered through adequate insurance coverage, and it would be helpful to get the advice of a good commercial insurance agent.

In North Dakota there are several hybrid structures. They include:

  • Limited Liability Partnership (LLP)
  • Limited Liability Limited Partnership (LLLP)
  • Professional Limited Liability Partnership (PLLP)
  • Limited Liability Company (LLC)
  • Farm Limited Liability Company
  • Professional Limited Liability Company (PLLC)

Limited Liability Partnership (LLP), Limited Liability Limited Partnership (LLLP) and Professional Limited Liability Partnership (PLLP)

Complexity
In all forms of limited liability partnerships you will generally encounter a more complex situation than the other partnerships. There should be a written partnership agreement and a registration of the entity is required with the Secretary of State. You can obtain the necessary form from the ND Secretary of State.

Liability
Unlike the general partners in the other partnerships, partners in a limited liability partnership enjoy limited liability, like an owner in a corporation.

The partnership agreement should create a centralized style of management, similar to a corporation, rather than all members sharing control (which is a partnership attribute). Centralized management establishes a managing partner or partners who make the operational decisions.

Just like a corporation, the limited liability is not absolute. Refer back to the C corporation article for the circumstances when an owner in the corporation will be held liable. The same circumstances are applicable to the partners in this structure.

Number of Owners
This factor is the same as the other partnership forms. There must be at least two owners.

Capital
Capital is generated only from the personal assets and good names of the partners involved.

Taxation
A limited liability partnership can elect to be taxed as a partnership or as a corporation. A limited liability partnership is automatically taxed like a partnership unless it files an Entity Classification Election Form 8832 and elects to be taxed like a corporation.

The same considerations previously discussed in making the Sub-chapter S election are applicable here as well. There has to be a timely filing. Be sure to plan for all partners’ personal tax issues and the business tax issues over the long run. Also, make sure you’re confident in your election as there is a 60 month limitation rule that makes it difficult to change to another form of tax entity within the 5 year period.

Survivorship
For survivorship, the limited liability partnership is treated like a general partnership - it “dissolves” upon the death of a partner. As we discussed in the general partnership article, it may choose to not formally liquidate the assets and “terminate”, but it legally becomes a different partnership.

Limited Liability Company (LLC)
The limited liability company (LLC) is created by choosing no more than 2 of the following corporate attributes: centralized management, continuity of life, free transferability of interests, and limited liability.

Complexity
The limited liability company is possibly the most complex structure to set up, but is also the most flexible. You need to file Articles of Organization with the Secretary of State’s office, making your selection of corporate attributes. The Articles themselves are usually basic, similar to the articles of incorporation for a corporation.

By-laws can be created, but are not required, to establish the operational rules of the business. These are similar to a partnership agreement. You can also obtain information on the required Articles of Organization format from the ND Secretary of State.

Number of Owners
There can be as few as one member if desired. If there is only one member, then the LLC is automatically treated as a sole proprietorship for tax purposes. The one member can elect to be taxed as a corporation by filing the IRS Entity Classification Election Form 8832 as mentioned in the limited liability partnership section above. There is no limit on the number of members an LLC can have.

Capital
The ability to raise capital can have an impact on whether the LLC is taxed like a partnership or a corporation. Free transferability of interest is one of the corporate attributes that can be selected. If you structure the LLC so that members may easily transfer their interests in the LLC, then you can raise capital by selling small pieces of the business like corporate stock. If you choose to structure it like a partnership, where the ownership is not easily transferable, then the ability to raise capital is limited to the personal assets and good names of the members, like a partnership. Please remember that offering and selling securities (stock) is governed by the North Dakota Securities Department. Generally these apply if you are offering and selling securities to the general public.

Taxation
An LLC can elect to be taxed as a sole proprietorship, partnership or as a corporation. If the LLC has only one member it is automatically treated, for tax purposes, as a sole proprietorship. If the LLC has more than one member it is automatically treated, for tax purposes, like a partnership. The LLC can elect to be taxed as a corporation by filing an Entity Classification Election Form 8832. If the corporate taxation structure has been elected, the LLC can also choose to file a Sub-chapter S election discussed previously in the prior series article. Again, be sure to plan for all partners’ personal tax issues and the business tax issues over the long run.

Survivorship
The LLC is assumed to have perpetual life unless stated otherwise in the articles of organization. You may choose a date that the entity will terminate.

If you’ve been following the series of business structure articles, you now know why it’s important to put some thought and planning into this decision! If you would like to talk out your options, please feel free to reach out to one of SBA’s resource partners for free and confidential counseling: the ND Small Business Development Centers (SBDC) or SCORE.


Mike Gallagher, District DirectorMike Gallagher joined the U.S. Small Business Administration in 1984 as a Business Development Specialist.  He was chosen as the Deputy District Director in 2005 and the District Director in November 2013.  A graduate of the University of North Dakota, Mike is a Certified Public Accountant and a former business owner.  He can be reached at michael.gallagher@sba.gov.

 

Other Articles in this Series

How Do I Choose a Business Structure?

Pros and Cons of Sole Proprietorships

The Ins and Outs of Business Partnerships

6 Things to Consider Before Incorporating Your Business