For those intending to form a closely held operating business in Florida, the entity of choice, in most cases, will be a limited liability company (LLC) that elects to be taxed as a Subchapter S corporation.
Following the issuance of “check the box” regulations in 1997, eligible entities (including eligible LLCs) have been able to select their federal tax classification. Eligible entities, such as the LLC, may elect to be taxed as a C corporation, an S corporation, a partnership, or, in the case of single member LLCs, a disregarded entity. As a result, since 1997 practitioners have been able to select the best combination of state law attributes and federal tax treatment to achieve a legal structure suited to the particular needs of a business.
The LLC constitutes a hybrid structure that marries the benefits of an LLC (a function of state law) with those of an S corporation (a function of federal tax law). This marriage achieves three principal benefits: 1) protection of the owners’ interests in the company from their personal liabilities (“asset protection”); 2) protection of the assets of the owners from the liabilities of the enterprise (“limited liability”); and 3) the lowest federal employment tax liability for owners employed by the business. The LLC is the only Florida entity that provides all three of these benefits.
Asset Protection Benefit
Among the most material of these benefits is the protection provided by F.S. §608.433(4), which safeguards the membership interest of an LLC owner from loss by limiting a creditor to the remedy of a “charging order.” While a charging order provides a creditor with the rights of an assignee, which entitles a creditor to receive distributions to which the debtor-owner would otherwise have been entitled, the debtor-owner will continue to own its membership interest in the LLC and, otherwise, operate its business without interference from the creditor. The creditor cannot vote on business matters, inspect or copy business records, nor exercise any of the debtor-owner’s rights with respect to the management of the business. Conversely, the owners of a corporation (both S and C) have no similar benefit, as their creditors are not limited in their remedies to a charging order. Accordingly, the Florida LLC provides a distinct measure of “asset protection,” while the Florida corporation provides none.
Limited Liability Benefits
Of the limited liability entities in Florida offering both asset protection and limited liability, LLCs offer the most secure limited liability shield – a shield equivalent to that of a corporation. F.S. §608.701 provides that in any case in which a party seeks to pierce the veil of an LLC, the court must apply the same case law as would apply to the piercing of a corporate veil under similar circumstances. As a result of the Florida Supreme Court case Dania Jai-Alai Palace, Inc. v. Sykes, 450 So.2d 1114 (Fla. 1984), which held that a corporate veil could not be pierced without a showing of fraud or an improper purpose, the limited liability shield of a Florida corporation is among the most difficult to pierce in the United States. Mere disregard of corporate formalities, inadequate capitalization, informal loan transactions, and similar poor practices will not justify piercing the corporate veil in Florida.
Federal Tax Benefits
Why should a closely held operating business formed as a Florida LLC elect taxation as an S corporation? Taxation as an S corporation offers two principal advantages. First, the Internal Revenue Code of 1986, as amended, provides that the profits and losses of an S corporation flow through to the owners in a manner similar to a partnership, thus avoiding double taxation. Second, employee-owners may be able to reduce federal employment taxes by as much as 15.3 percent on the portion of their income equal to or below $87,000 per year, and 2.9 percent on income in excess of $87,000. This tax strategy, which is a function of reducing wages and increasing distributions, is only available to entities taxed as S corporations.
Finally, until 2003, C corporations enjoyed an advantage over S corporations, since C corporations were the only federal income tax entity where the health insurance costs of owner-employees were fully deductible. Pursuant to Code §162(l), beginning in 2003, regardless of the taxing entity chosen, all self-employed individuals can deduct 100 percent of the amount paid for accident and health insurance premiums.
Because of superior asset protection, limited liability, and tax savings, a substantial majority of Florida operating businesses will be best served by an LLC.
*Adapted from The LLC Envelope, Florida Bar Journal, December 2003.