Part nº2: Advantages of a Delaware LLC - a 3 part series providing an in-depth analysis of Delaware LLCs, by Dennis Swing Greene.
A Limited Liability Company: Disadvantages
Choosing to use a Delaware Limited Liability Company can have long-reaching repercussions: taxes due, personal liability as well as applicable rules and regulations in the US and elsewhere.
- “Boomerang Effect” on Capital Gains Tax: Limiting liability can work in two directions. While an individual's financial liability can be curbed by low share value, the same bargain basis will also exaggerate eventual Capital Gains when shares are ultimately sold at a price reflecting the actual market value of the Company’s property.
- Individual analysis: To the degree possible, it is also important to evaluate the individual’s true liability potential. For a possible “deep-pocket”, protecting against financial liability can be a major factor. For others, personal responsibility questions may constitute only an incidental risk.
- Tax flexibility can backfire: Unless Owners choose to be taxed like a corporation (referred to in the US as “check-the-box” with corporate tax fixed at 40%), income from an LLC is subject to self-employment taxes in the jurisdiction where the shareholders are resident for tax purposes.
For example, if you have Local Lodging income from tourist lets in Portugal, you will not be eligible to be assessed according to the rules of the Simplified Regime. This means that you will pay at marginal rates, which can go as high as 48%, rather than just 5% as an individual.
- No “IRS” tax credits or deductions: In addition, this form of income is not eligible for individual tax credits or deductions on earned income. While taxed individually, calculations are based on corporate rules that may not be relevant to your situation.
- Steep mark-ups: Because of the relatively simple structure of a Delaware LLC, set-up charges can run as little as US$300 (€235). While this basic low cost should work to the Owners’ advantage, it often backfires, leading to successive intermediary mark-ups that can inflate charges by as much as ten-fold or more.
- Confusion about Roles: Whereas corporations normally have specifically defined roles (like directors, managers, and employees), LLCs generally do not. It can be difficult for the company and especially investors to know who is in charge, who can sign certain contracts, etc. This confusion can be avoided by creating a personalised LLC Operating Agreement.
- “FBAR” compliance: If a Delaware Company has a financial interest in or signature authority over a foreign financial account, the US requires annual reporting to the Internal Revenue Service (“FBAR”). This requirement can undermine any element of confidentiality in addition to adding another on-going compliance commitment and cost.
- “Controlled Foreign Company” scrutiny: A Delaware LLC is normally considered to be a Controlled Foreign Corporation. (A CFC is a corporate entity that is registered and conducts business in a different jurisdiction or country than the residency of the controlling owners.) When no normal commercial business activity is in place, these entities are likely candidates to increased suspicion, scrutiny and information sharing by Tax Authorities throughout the European Union and beyond.
Next: Capital Gains Tax Treatment of a LLC
Dennis Swing Greene is Chairman of the Board and International Fiscal Consultant for euroFINESCO s.a. Private consultations can be scheduled at in Guia (Albufeira) 289 561 333, Lisbon (Chiado) 213 424 210 and in Funchal (Sé), Madeira 291 221 095, by email at info@eurofinesco.com or on the internet at www.eurofinesco.com.