A relatively new way of forming a business entity could prove to be the most profitable when it comes to operating a ski resort or a related business. The limited liability company (LLC) has many benefits and some possible pitfalls that every ski and snowboard resort owner and operator should delve into. And once all of the advantages and disadvantages are considered, the LLC might look worthwhile when it is compared to sole proprietorships, partnerships, corporations and even “S” corporations.
The LLC is essentially a hybrid of a corporation and a limited partnership that is usually created under state law. When it is properly structured, the LLC is taxed as a partnership for federal income tax purposes. That means that the entity itself pays no taxes; instead federal income taxes are levied only on the individual LLC members (essentially shareholders or partners) and winds up being reported on their tax returns. Best of all, LLC members, like corporate shareholders, cannot be held personally liable for any of the debt or liability assessed against any ski resort or business that is operating under limited liability status.
Greater Flexibility
Of all the types of business entities that can be formed by the average owner or operator, one of the most basic, the regular or “C” corporation, is subject to the most aggressive tax bite. Their earnings are basically taxed twice. First, a corporate income tax is assessed against the firm’s net earnings and then, after the earnings are distributed to shareholders as dividends, each of those shareholders must pay a federal tax separately on his or her share. Since no tax deductions can be claimed by an incorporated ski resort for distributions of dividends, there are few other chances of easing the overall, double tax drain.
This form of taxation differs radically from that applied to S corporations, sole proprietorships, partnerships as well as limited liability companies. None of these business entities pays a tax on the corporate level. Only the owners, partners or members of these entities are taxed on their share of the entity’s earnings as was described for an LLC.
If this sounds similar to the arrangement you’re currently operating under, it may well be, except that an LLC offers ski resort owners and operators even greater benefits and more flexibility than an S corporation. There is, for example, no limit on the number of shareholders that can be included in an LLC. An S corporation, on the other hand, generally has a limit of 75. And all members or owners of an LLC can have a full participatory role in the business’s management without risking personal liability; in a limited partnership, for example, limited partners are not permitted any say in the company’s operation, only the general partners are.
The rules governing S corporations also restrict shareholders to individuals who are U.S. residents. LLCs, on the other hand, can be comprised of other corporations, partnerships, nonresident alien shareholders as well as trusts. On top of that, S corporations cannot distinguish between equity owners when it comes to allocating revenue or dividing up losses. The hybrid LLC, like some other partnerships, can make disproportionate distributions to its owners or members. A member of an LLC might, for instance, have a 50 percent ownership interest in the company but remain entitled to 60 percent of the annual income, provided the original operating agreement was written that way.
The LLC can even distribute appreciated property to LLC members without the need to identify gains on the corporate level. And those members are able to exchange appreciated property for membership interests in the LLC without reporting a gain or loss, avoiding tax consequences for such transactions.
Opening Doors to Lending
Aside from operational and taxation features, an LLC also opens some additional doors when it comes to borrowing capital. Often, in today’s business climate, restrictions are placed on the ways a company can do business or how it can use the money lent by its creditors. With an LLC, however, under some transactions, creditors are allowed to accept a membership interest in exchange for capital rather than place limits or restrictions on the activities of the ski resort or its related business.
Further, an LLC can prove to be an extremely useful corporate structure when it comes to attracting venture capital. An LLC, after all, allows for any investor-member to contribute guidance and suggestions related to the company’s operation. In addition, it grants the company considerable flexibility in structuring its management and, of course, paves the way for that all-important, single-tier tax treatment, making it look attractive to possible investors.
However, limited liability companies do not have any stock to offer investor-members because their business structure is akin to a partnership. Because of this, if after considerable evolution as a company the LLC management gets to the point where it is ready to make a public offering, the LLC would probably have to be dissolved and the corporate entity would have to be reconfigured according to state statutes.
Finally, under an LLC, if services are received in exchange for shares of partnership capital, there’s no report of income. In other words, those services don’t create any federal tax bill. Generally, any shareholder who receives unrestricted S corporation stock in return for his or her services must report it as taxable income. There is, however, no reportable gain to the S corporation.
The Flip Side
On the downside, there’s no uniform federal law that prevails over LLCs, making doing business in more than one state difficult for entities with resorts in different states or resorts that straddle a state line. State laws governing the format vary, but generally the LLC is seen as a hybrid of a traditional corporation and a traditional general partnership; taxed like the latter and provided liability protection like the former.
Limited liability companies, as a general rule, are also usually closely-held, limiting the transferability of membership interests. Transferring such interests is much easier in a typical corporation and other traditional companies where stock is commonly exchanged.
Again, like partnerships, LLCs cannot exist perpetually. Some state regulations stipulate that the limited liability company must dissolve after 30 or 40 years. Conversely, many small companies obviously tend to last much longer than that, especially if they are family-run businesses.
But though LLCs can contain as many partners as they want, state laws generally have stipulated that LLC formation contracts, with the list of members included, have to be redrawn if the membership changes. As a result, the LLC venture must dissolve when a member dies, quits or retires, so the company has to go through all the red tape and pay all the legal expenses involved in reforming the LLC all over again.
Finally, the dreaded alternative minimum tax (AMT) is applied at the shareholder level when the ski resort operates as an S corporation. With an LLC or partnership, the AMT is applied at partner level. The AMT, as most owners and operators are already aware, is a “minimum” tax to insure that no individual or business entity completely escapes taxes merely because of otherwise legitimate tax deductions or benefits.
Today, state-registered LLCs are becoming an extremely attractive option for many owners and operators and a significant number of partnerships, sole proprietorships, real estate ventures and S corporations have already converted. The circumstances that make one type of business organization favorable are always subject to changes in the tax law, so it makes sense to reassess the way your business is formed from time to time to make sure you are using the one that provides the most benefits. Right now, however, there are few better ways to conduct a joint venture or special project—or run a ski resort.
—Mark Battersby is a freelance writer, lecturer and corporate advisor specializing in business taxes and other financial matters.
