Volume 9 • Issue 3 • March 2019
The Counselor is a monthly newsletter of Hallock & Hallock dedicated to providing useful information on estate planning, business succession planning and charitable planning issues. This month’s issue is a playbook for your Limited Liability Company (LLC). If you are interested in learning more about the ideas and processes discussed in this newsletter, please contact us for an initial consultation.
Over the last few decades, the limited liability company (LLC) has become the entity of choice for most businesses. The LLC is a form of business entity that provides the limited liability of a corporation, but without many of the legal formalities. LLCs are authorized by state statute and are legally distinct from the owners. The LLC can own property, incur debts, enter into contracts, sue, and be sued. The owners of an LLC are referred to as members. An LLC can have one member (a single member LLC or SMLLC) or many members (a multi-member LLC). Members may be any combination of individuals, corporations, partnerships, LLCs, trusts, or other legal entities. While the LLC is governed by state law, through the adoption of an operating agreement, the members can determine for themselves the rules for many, if not most, issues related to the company, its management, and its organization.
It is important for you to understand the basics of maintaining your LLC in order to maintain the limited liability shield. This newsletter is an adaptation of a playbook provided to clients of Hallock & Hallock and is meant as a guide to maintaining your LLC. This guide should not be considered as a substitute for engaging a professional advisory team to help you navigate the rules and use them to benefit your business.
LLCs can be member-managed or manager-managed. In a member-managed LLC, the members manage the company by membership voting. In a manager-managed LLC, members appoint one or more managers to conduct LLC business as authorized by the members. A manager can be a member of the LLC, but does not have to be. Even in a member-managed LLC, a “day-to-day” manager is sometimes appointed to conduct daily business operations, but without decision-making authority.
Observe Formalities to Preserve the Liability Shield
The LLC is a legal entity or “person,” separate from its members, managers, officers (if any), and employees. If maintained correctly, the LLC will shield its owners from personal liability. To accomplish this goal, it is essential that the separate existence of the LLC be recognized and respected.
Any business done by the LLC should be conducted in the LLC’s name to preserve its status as a legal person. Business should not be conducted by the owners in their individual capacity, but only in their business capacity, such as “Member” or “Manager.”
It is important that receipts and disbursements flow through the correct entities. For example, if rent is received by the LLC from a property owned by the LLC, the rent should be deposited in the LLC’s account. Business transactions must always be done through business, not personal, accounts.
Creating a paper trail by writing checks to appropriate persons or entities makes it difficult for anyone to argue that there was no business purpose when in fact the LLC was managed like a business. On the other hand, if this is not done, it can be argued that there was no business purpose, and that the LLC should be disregarded as a separate legal entity.
Personal Liability for Members
There are certain situations that could trigger personal liability for members of an LLC. These include failure to observe formalities, failure to remit payroll or other taxes, committing tortious acts, or acting in your personal capacity as guarantor, among others. As time passes, the law could change exposing you to personal liability for other acts. For this reason, it is important to keep the lines of communication with your professional team, especially your attorney, open so you can stay apprised of such changes in the law.
Income Tax Attributes
Unless an election is made, an LLC with only one member is taxed as a disregarded entity similar to a sole proprietorship. An LLC with two or more members is taxed as a partnership by default. This means that the income derived from the LLC’s business that is due to each member gets reported on each member’s personal tax return. The LLC files an informational income tax return but does not pay income taxes itself. An LLC may also elect to be taxed as a C-corporation or S-corporation.
Before transferring property into or out of your LLC, please consult with an appropriate professional to be sure you are aware of the potential tax consequences of such transfers.
Maintaining Proper Insurance Coverage
Although your LLC provides limited liability if properly maintained, it is always a good idea to invest in a solid commercial general liability policy, and any specialized coverage related to your specific operations. Most policies will appoint counsel and cover the cost of your defense if you are sued or forced into arbitration. Insurance proceeds provide an easy alternative to costly litigation with uncertain results. Insurance policies should be obtained in the name of the LLC or transferred to the LLC. Premiums should be paid by the LLC. Where possible, the Member(s) of the LLC should be named as additional insureds.
Additional Protection Using LLCs
Creating subordinate LLCs to own risky property can be an effective tool to contain the damages resulting from a lawsuit involving the property that created the liability. Using LLCs to insulate risky assets from safe assets will make a lot of sense for individuals who have personal risk. Risky assets held in a separate or subordinate LLC do not contaminate the safe assets held in the LLC itself or in other LLCs if the entities are operated properly.
Taxpayer ID or Employer Identification Number (EIN)
An LLC that is not treated as a disregarded entity, or one that employs workers, must obtain a taxpayer identification number by submitting Form SS-4 Application for an EIN to the Internal Revenue Service (IRS). Each LLC, other business entities, and some trusts owning an interest in the LLC must have its own taxpayer identification number. Think of your EIN as your company’s social security number.
Because your LLC can be taxed in a variety of ways (disregarded entity, partnership, S-Corporation, C-Corporation), it is important to discuss the applicable required tax returns and filing deadlines with your attorney or your CPA. DEPENDING ON YOUR TAX STATUS, YOU MAY BE REQUIRED TO FILE A RETURN EARLIER THAN APRIL 15. Additionally, where the LLC is taxed as a partnership, the company must appoint a Partnership Representative to communicate with the IRS on tax and audit issues.
Local Business License
You are required to get a local business license in the city or county your business is headquartered. This includes working from home, if your home address is the incorporation or headquarter address of your business. The permit application may include getting zoning clearance for your work site. You may be required to register a fictitious business name with your county, if the business name you will be using is different from the name registered on your Certificate of Organization. Specific industries may have other required licenses or permits. Feel free to contact us if you are not sure whether you need additional licenses or permits.
Sales and Use Taxes
Your business may be subject to sales and use tax, and may require a state-issued reseller’s permit to operate. Please check with us or your CPA if you are unsure about the company’s obligations with regard to these taxes.
Many states require an annual report to be submitted to the appropriate State agency. Please put this date on the calendar to ensure it is submitted in a timely manner. Failure to submit the Annual Report on time can result in penalties and potential dissolution of your Company.
The company is required to maintain an agent for service of process who is responsible for receiving official mail and services of process for lawsuits or other claims. Any changes to your agent for service of process must be reported to the appropriate State agency.
An operating agreement is the legal document that governs the relationship between the members and managers (if any), and provides how decisions are made within your company. The operating agreement should be reviewed carefully to be sure you understand your obligations—and those of your fellow members, managers, and officers—fully. If you have any questions relating to any of the provisions in the operating agreement you should contact your attorney. Abiding by the provisions of the operating agreement is imperative to keeping your liability shield intact. The operating agreement should spell out the requirements related to company meetings, including provisions related to annual and special meetings, required notices, and waiving notice.
Limitations on Transfer of Ownership
Be aware that you may be limited from transferring membership interests due to an S-Corporation tax election, securities regulations, and/or limitations set out in your operating agreement, buy-sell agreement, or the law. Ensure you are in compliance with these possible limitations before attempting to transfer or sell any LLC ownership interests. Contact us before you attempt a transfer if you are in any way unsure.
Contributing Real Property to your LLC
Contributing real estate or contracts can be complex. Real estate transferred without lender consent can accelerate mortgage debt. Contributing leases or other contracts can void or change the terms between the parties. Contributing tax-deferred installment notes can accelerate the recognition of the deferred taxable gain. You should review your title insurance with any carrier to determine if any endorsements are required. If you are considering titling any real property in the name of your LLC, you should discuss the matter with your attorney.
Federal and State Securities Laws
The LLC could be subject to federal and state securities laws. Your attorney and CPA must determine whether they apply. If they do, all sales of and offers to sell any LLC units must comply with both federal and state securities laws. Failure to comply can result in serious consequences.
The legal requirements relating to disclosure and registration of offering securities are complex. You should get legal advice when developing any financing plan and before offering to or contracting with any person for the sale of any LLC interests. If you do not properly handle matters from the outset, the financing opportunity may be legally barred.
State law decrees that certain written records must be kept and maintained at the principal or registered office of the LLC. Any member or assignee may make a request of LLC information at any reasonable time and make copies free of charge. The records must be in written form or be able to be reduced to written form. Another issue to consider is meticulous maintenance of any member entity’s records. If an entity is a manager, for example, books and records must be kept up to date, tax returns must be properly filed on time, and all state reports must be filed timely.
This playbook is not meant to be comprehensive in covering all of the matters that can arise. Therefore, a regular annual meeting with your attorney and professional advisory team is an excellent way to make sure that your LLC continues to provide the protections and fulfill the purposes for which it was created. If you are interested in learning more, please considering meeting with our attorneys for a business check-up.
This Newsletter is for informational purposes only and not for the purpose of providing legal advice. You should contact an attorney to obtain advice with respect to any particular issue or problem. Nothing herein creates an attorney-client relationship between Hallock & Hallock and the reader.