Screen printers, take note: There’s a relatively new business structure on the block. While the S corporation re-mains the most used type of small business entity, the limited liability company, or LLC, is increasingly becoming the en-tity of choice for both new and existing screen-printing businesses.
LLCs are popular structures for screen-printing operations because, as with an incorporated business, owners have limited liability for the company’s debts and actions. This article describes how your company might benefit from forming or restructuring as an LLC.
LLC is a business structure that combines the pass-through taxation of a partnership or sole proprietorship with the limited liability of a corporation. As is the case with owners in partnerships or sole proprietorships, LLC members report business profits or losses on their personal income-tax returns; the LLC itself is not a separate taxable entity. Other features of LLCs are more in line with a partnership, such as providing management flexibility and the benefit of pass-through taxation.
Owners of an LLC are called members, and since most states do not restrict ownership, members may include individuals, corporations, other LLCs, and even foreign entities. There is no maximum number of members, and most states also permit single-member LLCs, those having only one owner. Only a few types of businesses cannot be LLCs, such as banks, insurance companies, and nonprofit organizations.Advertisement
Like owners of a corporation, however, all LLC owners or members are pro-tected from personal liability for business debts and claims—a feature known as limited liability. This means that if the business owes money or faces a lawsuit, only the assets of the business itself are at risk. Creditors usually cannot reach the personal assets of the LLC members, such as houses or cars.
Unlike S corporations, LLCs have no limit on the number or nationality of members, can own subsidiaries and can have more than one class of interest—a good method of unequally divid-ing income and losses. A limited liability company—yes, company, not corporation—can select varying forms of distribution for profits. Unlike a common partnership, where the split is 50-50, LLCs have much more flexibility. LLC profits are taxed only once, at the owners’ tax rate, when earned by the entity.
Sound like a partnership? Well, not quite. Even a limited partnership (LP) has one party who assumes liability—the general partner—and who usually must have substantial net worth. Furthermore, limited partners who participate in managing the screen-printing business risk losing their limited liability.
Viva the difference
Corporations are required to keep formal minutes, have meetings, and record resolutions. The LLC business structure requires no corporate minutes or resolutions and is easier to operate. In fact, in some states, LLCs can be created with just one natural person involved.Advertisement
All business losses, profits, and expenses flow through the screen-printing business to the individual members of the LLC. You avoid the double taxation of paying corporate tax and individual tax. This generally is a tax advantage, but circumstances can favor a corporate tax structure.
Probably most importantly, owners of an LLC have the liability protection of a corporation. An LLC exists as a separate entity, much like a corporation. Members can’t be held personally liable for debts unless they’ve signed a personal guarantee.
Admittedly, this limited liability is not foolproof. Both LLC members and cor-porate shareholders can lose this protection by acting illegally, unethically, or irresponsibly. Additionally, many courts are increasingly reaching behind the corporate veil into the pockets of members and shareholders who have not kept the business entity fully sepa-rate from their personal finances. Other disadvantages include, but are not limited to:
Limited life While corporations can live forever, an LLC is dissolved when a member dies or undergoes bankruptcy.Advertisement
Going public Owners of screen-printing businesses who have plans to take their company public, or to issue shares to employees in the future, may be best served by choosing a corporate business structure.
Raising capital It may be more difficult to raise capital for an LLC, as investors may be more comfortable in-vesting funds in the better understood corporate form with a view toward an eventual IPO.
Complexity Running a sole proprietorship or partnership usually involves less paperwork and is less complex. Under federal tax laws, an LLC may be classified as a sole proprietorship, partnership, or corporation for tax purposes. Classification can be made on the tax return thanks to the so-called Check-The-Box question on the tax return. If not selected, a default often applies.
Another downside is that the laws of various states governing LLCs vary. No uniform law prevails, thereby making doing business in more than one state difficult. Like partnerships, LLCs do not have perpetual life. Some states stipulate that the screen-printing business, when structured as an LLC, must dissolve after 30 or 40 years. Technically, an LLC venture dissolves when a member dies, quits, or retires.
Forming the LLC
An LLC can be formed in most states simply by filing articles of organization with the state’s LLC filing office—usually the Secretary of State’s office—and paying a filing fee. Many states, in fact, provide a fill-in-the-blank form that takes only a few minutes to prepare.
The operating agreement, for the most part, contains any procedures and rules that the parties desire and, once put into place, can just sit there, maintenance free. The operating agreement explicitly states the rights and responsibilities of the LLC members. Without a written LLC operating agreement, the LLC laws of your state will govern the inner working of the LLC. Generally, it is preferable to clarify your business arrangements and decide how your LLC will be run, rather than having the state dictate its terms.
No one needs any more red tape in his or her life. Under the LLC rules in most states, there is no need to keep exhaustive minutes, hold meetings or make resolutions to, in effect, stay legal. However, this freedom is often a trap for the unwary and is the first place the IRS or an aggressive attorney will attack when attempting to pierce the corporate veil and go after the shareholders personally. If records are not maintained perfectly, the LLC’s corporate protection may be lost.
In most situations, a screen-printing business operating as a partnership can quickly and inexpensively convert to an LLC. Partnerships can usually convert without tax consequences, with the new LLC continuing to file a partnership tax return with the IRS. Because of the similarity of the structure, the IRS does not usually look at the conversion as a taxable event.
A corporation can also convert to LLC status, although it may not be a wise move for the shareholders of many incorporated businesses. Generally, it is not feasible for a screen-printing business operating as a corporation, either a regular or as an S corporation, to convert to LLC status. IRS regulations require that the incorporated screen printer liquidate first, thus creating considerable tax liability.
To convert, a corporation must first be liquidated and pay tax on any gain in its fair market value. Even a corporation with depressed values that converts would have to be prepared to prove its estimate to the IRS. That could mean a costly appraisal.
As with many good things, there are tax questions surrounding the use of an LLC to operate the screen-printing business. For starters, there is the Self-Employment Tax Act (SETA). Limited partners and S corporation shareholders generally are not subject to self-employment taxes—a 2.9 percent Medicare levy on all salaries and 12.4 percent FICA (Social Security) tax on income up to $102,000 (in 2008)—but are passive LLC members?
The IRS’s position, subject to change, is that LLC members who participate in management are subject to employment taxes. According to the IRD, if LLC members are legitimate, passive members, they should not be subject to those employment taxes.
The LCC is OK—sometimes
Limited liability companies work for start-ups, for screen-printing operations branching out, and in lieu of LPs for such financial entities as trading pools and hedge funds. Lawyers are increasingly recommending them for estate planning—reorganize assets or the family business as an LLC, and you can gradually give most of the shares to your heirs while retaining management control.
The LLC is rapidly becoming the entity of choice for many business owners, shareholders, and partners in every realm. The LLC will continue to gain momentum as more and more people learn of its existence. You might be well advised to consider its many benefits—and its possible pitfalls—for your screen-printing business. Many screen printers, once they’ve considered all of the pros and cons, have discovered the LLC structure is the most profitable operating entity for their operations.
Mark E. Battersby is a tax and financial advisor, freelance writer, and columnist who’s been involved with tax-planning and related issues for more than 30 years. He works in Ardmore, PA. You can reach him through Screen Printing magazine by e-mailing [email protected]
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