Proper LLC Tax Election May Save Money

There are many factors that a business owner must consider when deciding whether to establish an LLC or a corporation.  (See YouTube video at: https://www.youtube.com/watch?v=_o2bPSaQRbI).  While both LLCs and corporations provide equivalent liability protection, LLCs have grown in popularity over the last decade, primarily due to the ease with which they can be organized.  In addition, unlike C-corporations, LLCs are not required to pay a separate corporate tax. 

Many business owners do not realize that an LLC can be taxed in a few different ways. In order to maximize the tax benefits of establishing an LLC, the business owner should choose the correct tax election in consultation with an experienced tax consultant.  This article is a basic summary of the different ways in which an LLC can elect to be taxed. This article is only an outline and any tax election decision should be made in consultation with an experienced tax consultant.

If the LLC does not make any tax election, then by default, a single member LLC will be treated as a “disregarded entity” for federal tax purposes, and a multi-member LLC will be classified as a “partnership” for federal tax purposes.  In such event, the LLC is not considered to be the “employer” of the member(s), and the member(s) are not considered to be “employees” of the LLC.  In lieu of the FICA payroll taxes that employees and employers of other business entities are required to pay, the members pay self-employment taxes pursuant to SECA in addition to their regular income taxes.

The LLC may avoid the default tax treatment described above if it timely chooses to be taxed as a C-corporation or as a Sub-S corporation.  (See http://www.irs.gov/publications/p3402/ar02.html).  While it does not usually make sense for an LLC to elect to be taxed as a C-corporation, since such election destroys one of the principle reasons for establishing the LLC (i.e. the avoidance of the corporate tax), it might make sense for the LLC to elect to be taxed as a Sub-S corporation.  The primary reason is that if the LLC elects to be taxed as a Sub-S corporation, then the members can be treated as employees of the LLC and pay themselves “reasonable compensation” as W2 wages subject to FICA payroll taxes (in lieu of SECA taxes).  The members can also pay themselves any remaining company profits as distributions.  In many cases, the SECA tax rate is higher than the FICA tax rate, and thus the members may save on taxes by establishing the employer/employee relationship. In addition, in most cases, the excess distributions from a Sub-S corporation to the members are not subject to FICA taxes or SECA taxes, and the members need only pay regular income taxes on such income.  Of course, the IRS carefully scrutinizers the tax treatment of sub-S corporations in order to prevent tax avoidance, and the sub-S election is not appropriate for all business owners.   

Another tax consideration for the business owner to consider is how the income, deductions, gains, losses and tax credits will be allocated to the members of a multi-member LLC.  The operating agreement of the LLC should specify this allocation.  (See YouTube video at: https://www.youtube.com/watch?v=DiLfBzKNAeM)  While the IRS gives the LLC flexibility for such allocation, it also imposes limitations to prevent an LLC from allocating disproportionate losses to high income earners for the purpose of offsetting income from outside sources.  A Sub-S corporation is required to allocate these items consistent with ownership percentages. The members are required to have a basis in the entity in order to deduct losses currently.

In order to maximize the tax benefits of establishing an LLC, the business owner should consult with an experienced tax consultant regarding tax elections and the tax provisions of the LC's operating agreement.  Generally, an election specifying an LLC’s classification cannot take effect more than 75 days prior to the date the election is filed, nor can it take effect later than 12 months after the date the election is filed.

For assistance in organizing an LLC, contact Gross & Romanick at 703-273-1400, or contact Edward Gross directly at law@gross.com. 

This article was edited by Thomas G. Jenkins, CPA, of Thomas Jenkins and Company, P.C., whose office is located in Camp Springs, Maryland.  Thomas G. Jenkins may be contacted directly at 301-423-4474.

Terrorist Attacks and Landlord Liability

This article briefly discusses the responsibility of commercial property owners for the safety of tenants and building invitees in the event of a terrorist attack.

If a person injured as a result of a terrorist attack at the owner’s property sues the landlord, we expect that the Courts will rely on the general body of “premises liability” case law to decide the lawsuit.  The very general rule espoused by the majority of Courts in the United States is that commercial property owners do not have a duty to protect tenants and invitees from the criminal acts of third parties.  The general exception to the rule is that if imminent harm is foreseeable to the owner, and the owner does not take reasonable steps to warn or protect tenants and invitees of the harm, the owner can be held liable.

These general principles were espoused in the case of Jane Doe v. Dominion Bank of Washington (U.S. Court of Appeals for the District of Columbia), where the Court stated as follows: “A commercial landlord must exercise reasonable care to protect tenants from foreseeable criminal conduct occurring in common areas under the landlord’s control”. The Court further stated that: “D.C. law imposes a heightened standard of foreseeability on plaintiffs seeking to hold a landlord liable for injuries resulting from a criminal act.”  In that case, a rape victim was allowed to proceed with her case because the court found deficient building security in a building where numerous assaults and crimes had taken place. Similarly, in Thompson v. Skate America, the Supreme Court of Virginia allowed the plaintiff to proceed with his case against the owner of a skating rink based on the allegation that the owner failed to protect invitees from the criminal acts of an individual that the owner knew was a menace to patrons of the skating rink (and had been ejected from the rink on prior occasions). 

Given the fact that large-scale terrorist attacks by their very nature are not predictable, we do not expect that commercial property owners will be held liable for injuries and property losses to tenants and invitees just because the injuries/losses occur on the owner’s property (although every case is different and will be decided on its own merits).  Rather, individuals and families will need to look to insurance companies, government funds and charitable organizations for compensation, as was the case in the wake of the 9/11 attacks (See http://www.rand.org/pubs/research_briefs/RB9087/index1.html). 

This raises the question:  What should commercial property owners do to limit potential liability? The first thing the owner can do is review its insurance policies to determine whether the owner is covered from terrorist attacks.  Many policies specifically exclude terrorism.  The second thing the owner should do is review its emergency preparedness plan for the building with its property managers and tenants. The plan should not address terrorism specifically, but rather, should provide general guidance to property managers and tenants regarding notification and evacuation in the event of an emergency or other imminent harm to the building or its occupants (including terrorist attacks). The existence of such a plan and the adherence to the plan in the event of an emergency could improve the landlord’s position if the landlord is sued for negligence following a terrorist attack.  Finally, the landlord may want to consult with a security firm regarding the building’s exposure to criminal activity and determine whether simple measures could be installed to deter such activity (such as installing cameras or additional locks).

In short, taking action to specifically prevent terrorist acts may in many cases be counterproductive and is not required by law, but planning for general emergencies (including terrorist acts) may limit the property owner’s exposure to liability.