Limited Liability Companies Lawyers in Pennsylvania
On December 7, 1994 former Governor Robert Casey signed into law Pennsylvania Act 106, which for the first time authorized the formation of Pennsylvania limited liability companies and limited liability partnerships. Act 106 was hailed for creating exciting new possibilities for the organization of Pennsylvania business, allowing Pennsylvania to compete on even footing with other states that had long since enacted legislation allowing businesses to form as LLC’s and LLP’s. Unfortunately, the fanfare was short-lived. Attorneys and accountants found that there were unanswered questions about whether Pennsylvania LLC’s could qualify for pass-through taxation -- taxation of the LLC members as a partnership in the manner of a subchapter S corporation rather than taxation of the LLC itself. These unresolved questions rendered the LLC form essentially useless and indeed dangerous for the small business owner.
At the federal level, LLC’s were subject to the uncertainties of a six-factor test
used to determine whether they would be treated as partnerships or corporations for
federal taxation purposes. Although Pennsylvania law permitted the formation of an
LLC with a single owner, the IRS would not consider treating an LLC as a partnership
unless it had at least two members. Pennsylvania law provided further complications. At
the state level, the Pennsylvania Tax Code did not permit LLC’s to elect taxation as
Pennsylvania subchapter S corporations. The result was that even if an LLC could qualify
for pass-through taxation at the federal level, it was nevertheless subject to
Pennsylvania’s high corporate tax rate. Practitioners promptly abandoned the idea of
organizing small businesses as LLC’s, and stuck with the tried and true, though more
cumbersome structure of the subchapter S corporation.
All of that changed with the Internal Revenue Service’s "check the box" proposal,
implemented by Treasury Department regulations which became effective January 1,
1997. These new regulations replaced the unpredictable six-factor test with a scheme
allowing the owners of a non-corporate business to elect to treat the business as either a
"disregarded entity" (partnership or sole proprietorship) or an association taxable as a
corporation. Further, a 1997 amendment to the Pennsylvania Tax Code permitted LLC’s
to elect taxation as Pennsylvania subchapter S corporations, thereby finally permitting
pass-through taxation at the state level.
With these changes in state and federal law, Pennsylvania small businesses
seeking limited liability are no longer forced into incorporation. Now there is a genuine
choice between incorporating and forming an LLC. Both forms provide for limited
liability protection, and both forms now permit pass-through taxation. On the downside,
both forms are subject to Pennsylvania’s capital stock and franchise taxes. It is also
likely that LLC’s, like corporations, will be subject to "piercing the veil" -- the imposition
of personal liability upon LLC members for the debts of the LLC itself in the event of
gross under-capitalization, failure to maintain required records, co-mingling of assets, etc.
So just as a corporation must maintain adequate capital, observe required corporate
formalities and avoid paying the prime shareholder’s grocery bills with checks drawn on
the corporate account, so too must the members of an LLC comply with similar
requirements to maintain impregnable limited liability protection.
For most Pennsylvania small businesses, there are now decided advantages for
choosing to organize as an LLC rather than incorporate. Some of the advantages are:
Flexibility in Ownership Rights. With a corporation, a shareholder’s right to
participate in profits, and the liability of his capital account are determined by the number
of shares he owns. The differentiation of shareholder rights through different classes of
stock can defeat a corporation’s eligibility for subchapter S election. With an LLC,
complex differentiation of the rights of members is permitted, and can be accomplished
simply by writing it into the members’ operating agreement. Through the device of an
operating agreement, members can adjust profit participation, loss deductions and
management rights to suit the company’s particular circumstances.
Corporations and Trusts as LLC Members. Corporations are generally not eligible for
subchapter S election if any of the their shareholders are corporations (as in the case of a
parent-subsidiary arrangement), partnerships or, in most cases, trusts. LLC’s have no
such limitation, and are therefore the business form of choice where a small business has
any owner who is not an individual person.
Management Formalities. Except in the case of statutory close corporations, a
corporation’s shareholders elect the board of directors, who in turn elect the officers of
the corporation. This is the case even where the corporation has only one shareholder.
With an LLC, management is at once more direct and more flexible. In the Certificate of
Organization, members can choose one or more member managers, or can instead choose
to be managed directly by the members, without appointing a particular manager.
For a small business seeking limited liability protection, LLC’s are now a viable
option, and in most instances should be considered the preferred option. Where the
subchapter S corporation was once the only choice, there are now few instances where an LLC
is not the better choice.
The attorneys of Wolf, Baldwin & Associates, P.C. can counsel you on the right limited liability vehicle for you. Please contact us to talk to one of our attorneys about your business goals. We look forward to hearing from you.
The materials contained in this web site do not constitute legal advice, and contact with us through this web site does not establish an attorney-client relationship. The legal citations quoted in this web site may not be up-to-date. We provide these materials for general information purposes only. We make no claims, promises, or guarantees about the accuracy, completeness, or adequacy of the information, whether contained on this web site or any other site to which we might link. No web site can substitute for the fully informed, reasoned judgment of a lawyer. You should not rely on any material contained in this web site - instead you should contact one of our attorneys for a full consultation.
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