Husband-Wife LLCs

The last few weeks, I’ve been discussing single owner business entities for limiting liabilities.  But what if both spouses are active in the business?    What liability choices are the best in this case?

 If you are unincorporated, “actively involved” means that the spouses hold themselves out as co-owners to third parties and share in the profits and losses.  In other words, the spouses conduct themselves as partners.  Such an unincorporated business is generally classified as a husband-wife partnership for federal income tax purposes whether or not there are any formal partnership agreements between the spouses.

 In this case a husband-wife LLC offers the maximum tax flexibility.  All 50 states and the District of Columbia now permit multi-member LLCs, or LLCs with 2 or more members.  LLC owners are referred to as members.  While LLCs offer corporate-style liability protection, they are considered unincorporated entities for federal income tax purposes unless an election is made on Form 8732 to treat the LLC as a corporation (which is relatively rare).

 Because the LLC is treated as a partnership (if no election has been made to treat the LLC as a corporation), no entity-level federal income taxes are paid.  Instead the income passes-through to the individual return, which can be a big advantage.  There are less restrictions than with an S Corporation (the income also passes through with this entity).

There are also several other tax advantages over the S Corporation.  The partnership tax rules are more flexible in regards to withdrawing cash or other assets from the LLC which causes less tax complications.  Those transactions can be accounted for at tax preparation time.

If an owner dies in an S Corporation, appreciated assets cannot be stepped up in value to their date-of-death fair market values.  In contrast, the LLC allows the heirs to benefit from tax basis step-ups which means lower tax bills for the heirs when assets are sold after death. 

With an S Corporation, no additional tax basis is given for entity-level debt.  However, additional basis is given for the husband-wife LLC.  When the business throws off tax losses, this advantage can allow bigger current deductions.  Also there is the possibility of refinancing real estate properties and taking out cash without triggering taxable gains.

For all these tax-related reasons, the husband-wife LLC is generally preferable to the S Corporations because taxpayers have greater flexibility to make a wide variety of transactions without triggering any tricky tax complications or adverse tax consequences.  There are some drawbacks however which we will discuss in my next post.