According to a 2011 study, more than 5.5 million family businesses are in operation in the United States. If two or more family members want to operate a family business, they can form a limited liability partnership. The LLP business structure is similar to a general partnership with the same taxation and management organizational structures. There are several advantages to running a family LLP business, but there are also some drawbacks.
Profits And Losses
An LLP is taxed like a general partnership with the pass-through taxation method. This means all profits and losses are passed down to the partners, who report their amounts on their individual tax returns. Each partner’s share of profits and losses are generally determined by their ownership stakes. For instance, if a family member owns 50 percent of the company, he would get 50 percent of the profits and losses. However, the partners can agree to allocate different percentages of profits of losses that suit the best interest of the company. Higher profits, for example, can be given to those who handle the most responsibility in the LLP.
Limited Liability Protection
Each partner in the family LLP is given limited liability protection against business obligations. If the LLP goes bankrupt or third parties bring lawsuits against the business, partners are not held personally liable to satisfy award damages or pay back creditors. Also, each partner is not liable for the actions of other partners. Limited liability protection doesn’t shield partners from their own wrongful actions, however.
Everyone Pays Self-Employment Taxes
One of the drawbacks of a family LLP is that all partners have to pay employment taxes on their incomes, because all are considered employees of the business, even if they play little or no active role in the business. This includes self-employment taxes, which are Social Security and Medicare taxes combined. As of 2013, self-employment taxes take up 15.3 percent of partners’ taxable incomes. However, the Internal Revenue Service does allow partners to deduct half of their self-employment taxes on their tax returns.
Keeping The Family Business Alive
Another drawback of running an LLP is that if one family member leaves the business, the company has to dissolve. This can be prevented by creating a partnership agreement. A partnership agreement is a voluntary document that serves as a guide to how the partnership is to be run. The partnership agreement entails how voting rights are delegated and profits and losses are distributed, as well as the roles and responsibilities of each partner. A partnership can also include how a partners’ interest can be bought out and be replaced in the event a family member leaves the business.
Not every family business can operate as an LLP. Some states limit the formation of an LLP to certain types of work. In California, for example, an LLP is restricted to professionals such as architects, accountants and lawyers. If a family business can’t operate as an LLP, there are other options available. One is forming a limited partnership. In an LP, partners who have active roles in the business are called general partners, and partners who want silent roles are called limited partners. In exchange for not having active roles, limited partners don’t have to pay self-employment taxes like the general partners, because they’re not considered employees. The disadvantage to this partnership is that general partners give up their liability protections. The benefit of an LP is that you can form one in any jurisdiction.