On occasion, part of running a real estate investment business or in the estate planning process may involve placing assets into an entity (1) to limit one's liability, and/or (2) to provide a vehicle through which ownership interest can be gifted to children or others on a phased basis over a period of time. In achieving these goals, three types of legal entities can be utilized: a Sub-Chapter S corporation, a limited liability company ("LLC"), or a limited partnership ("LP"). Each has certain advantages and disadvantages. The following is a comparison of each of these types of entities.
Ease and cost of formation: All three entities involve a fairly comparable level of difficulty in formation, with the limited partnership documentation being potentially the most involved in the event a corporate general partner is utilized for reasons discussed below. Differences in the amount of the initial filing fees with the Virginia State Corporation Commission ("SCC") are negligible: $75.00 for a corporation and $100.00 for a LLC or a LP. Currently, the annual registration fee for all three entities is $100.00 per year unless a corporation has in excess of 5,000 authorized shares, which would be unlikely for the typical estate planning vehicle.
Limitation of Liability: Both a corporation and an LLC afford all of those holding an ownership interest with a limitation from personal liability provided proper corporate or LLC formalities, as applicable, are followed. Therefore, maximum potential liability of each owner is capped at the value of his ownership interest in the entity. In the case of an LP, the general partner(s) will be liable for the debts of the partnership, while the liability of the limited partners is capped at the value of his/her ownership interest in the limited partnership. One method of controlling general partner liability is to form a closely held corporation to act as the general partner of the LP. This increases formation costs but may be a worthwhile investment depending upon the nature of the LP's assets and business.
Taxation: In the case of each type of entity, income passes through to the individual owners holding an interest in the entity and is taxed at the owners tax rate.
Number of Owners Allowed: A Sub-Chapter S corporation must have one or more, but less than 75 stockholders. An LLC must have at least one (1) member. An LP must have at least one general partner and one limited partner.
Ease of Transferring Interest for Estate Planning Purposes: A corporation affords the simplest method of transferring ownership interests to heirs: Shares are merely transferred and assigned and a new stock certificate is issued to the new owner in the amount of the transferred shares and a new stock certificate is issued to the grantor reflecting the reduction of shares owned. No modification or amendment of the corporation's organizational documents is required. In the case of both a LLC and a LP, some type of modification to the organizational documents will be necessary. For an LLC, this will entail amending the operating agreement for the LLC. For an LP, a modification of the limited partnership agreement will be required. In each instance, the modification is needed to (1) reflect the admission of the new owner and (2) confirm that the new owner agrees to be bound by the obligations imposed by and the terms of the organization documents of the entity.
Ability of Grantor to Retain Control: Of the three types of entities, the LP affords the general partner the most control over the entity's activities and business decisions. This is because the general partner(s) control the actions of the LP even if they only hold a one percent (1%) interest in the overall ownership of the total partnership interests. In the case of both a corporation and an LLC, once the grantor has gifted over more than fifty percent (50%) of the ownership interest, the parties holding more than 50% of the ownership, acting as a group, can take control of the entity
Handling of Entity Assets: No matter which form of entity is utilized, it is important to remember that the entity is a separate Aperson@ for legal purposes. Therefore, it is critical that the entity's assets and income be held and managed separate form the grantors personal assets and monies. All too often, this fact is forgotten and monies are co-mingled and treated as if they were still the grantor's personal assets. The consequences of failing to remember this distinction can be significant: Loss of the limitation of liability and potential problems with the Internal Revenue Service, which may perceive tax irregularities. Therefore, a grantor must be prepared to maintain separate financial books and not divert entity funds to himself/herself.
Which Form of Entity is Better: In operating a real estate investment business or in preparing an estate plan, without information concerning the assets involved and other relevant circumstances and goals of the grantor, it is difficult to say which type of entity may be better overall. Each form of entity has certain characteristics and advantages to recommend it. Consequently, in determining which entity form to choose will depend upon (1) the particular the goals the grantor is trying to achieve, (2) how much control the grantor seeks to retain and (3) the total facts surrounding the assets to be gifted in a phased manner. To review these factors and determine the entity that will best meet the grantor's particular needs, it is wise to consult you tax advisor and your legal counsel to ensure to the maximum extent practicable that the right entity form is selected.
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