In connection with the New Hampshire legislature’s expansion of the application of the Interest and Dividends Tax to include distributions made by limited liability companies, business owners may be reevaluating whether the limited liability company continues to be the best form of entity within which to operate their business. Prior to the tax law change, in most cases, the LLC was the best choice for small and mid-sized businesses because the LLC offered business owners the benefits of a favorable tax structure, liability protection, ease of formation, flexibility and ease of maintenance. Despite the recent tax change, which has caused LLCs and corporations taxed under Subchapter S of the Internal Revenue Code, S-Corps (the most obvious alternative option for many businesses), to be on an equal footing from a tax perspective (particularly with regard to New Hampshire business taxation), in most cases the LLC continues to be the best option for small and mid-sized business owners. However, with the New Hampshire business tax benefit being eliminated, business owners must now consider more closely the other factors that impact the selection of a business entity when deciding which entity is the best for their business.
Liability Protection. The LLC and the S-Corp each provide its owners with liability protection, so long as they are formed properly and maintained properly. The LLC provides owners of multi-owner LLCs with an enhanced level of protection known as charging order protection. Charging order protection limits the rights of a party bringing an action against the LLC owner by limiting their recovery to the economic benefit that flows through the LLC (the distributions that are made by the LLC). This charging order protection is not available to owners of corporations.
Ease of Formation. LLCs and S-Corps are both relatively easy to form, however, there are additional steps that must be taken to form an S-Corp and certain restrictions regarding who may serve as a shareholder of an S-Corp can apply. In particular, in connection with the formation of an S-Corp, the owners must file a Form 2553 with the Internal Revenue Service (no such filing is required when forming a LLC). The restrictions imposed on the S-Corp limit the S-Corp to no more than 100 shareholders and provide that the S-Corp cannot have corporations, many trusts, LLCs, partnerships, or nonresident aliens as shareholders. Limited Liability Companies are not subject to these same limitations.
Flexibility. An LLC provides business owners with a large degree of flexibility with regard to how the entity can be structured and how revenue may be allocated among its owners. S-Corps are required to allocate profits and losses of the business in a manner that is consistent with a stock ownership of each S-Corp shareholder. This flexibility makes the LLC more attractive in situations where business owners have a need to take advantage of this flexibility.
Ease of Maintenance. The LLC has the advantage of having relatively few statutory formalities that need to be followed by the owners. The benefit of having limited formalities is that the risk of a claim being brought by a creditor for failure to follow corporate formalities is significantly decreased with LLCs, which reduces the owner’s exposure to personal liability.
While the removal of the favorable tax treatment reduced the importance of one factor used to determine which entity a business owner should use to operate his/her business, there continue to be many reasons (charging order protection, flexibility of structure and ease to maintain) why business owners should continue to select LLCs as the entity of choice. For business owners that are currently using an LLC to operate their business, despite the New Hampshire business tax law change, there is no reason to change.
Patrick Closson is a member of the Corporate Department at the law firm of McLane, Graf, Raulerson & Middleton, Professional Association. He can be reached at [email protected] or (603) 628-1457. The McLane Law Firm is the largest full-service law firm in the state of New Hampshire, with offices in Concord, Manchester and Portsmouth as well as Woburn, Massachusetts.