Organizing Your Business – Why An LLC May Be the Right Fit For You
Volume 4 • Issue 3 • March 2014
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 will discuss Limited Liability Companies. If you are interested in learning more about the ideas and processes discussed in this newsletter please contact us for an initial consultation.
If you are considering starting a new business or re-structuring an existing business, the Limited Liability Company (commonly referred to as an “LLC”) might be a great fit for you. While the first LLC statute originated in Wyoming in the 1970s, it wasn’t until the mid 1990s that all 50 states and the District of Columbia had enacted LLC legislation. Over the last twenty years, the LLC has become one of the most favored forms of doing business. The LLC is a form of business entity that provides the limited liability of a corporation, but without some of the legal formalities. LLCs are authorized by state statute and are legally distinct from its 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.
Advantages of an LLC
Limited Liability: Unlike the sole proprietorship or partnership, the LLC, like a corporation, can protect its members from personal liability for business debts and claims as long as the LLC is properly managed. This means that if the LLC incurs debt or is sued, the members’ personal assets will generally be protected. However, this does not mean that members are shielded from their own wrongful acts. An LLC may have certain advantages over corporations in protecting LLC assets from the debts and liabilities of a member. This is dependent on state law and the drafting of the operating agreement.
Tax Efficiencies: LLCs are not taxed as a separate business entity. Instead, all profits and losses “pass through” the business to each member of the LLC. Each member reports the profit or loss on their individual tax return. Because of what is known as the “check the box” rule, the members can elect to have the LLC taxed as a disregarded entity (sole proprietor), a partnership, an S-Corp, or even a C-Corp.
Operational Flexibility and Ease: The LLC can be managed by the members or by a manager or group of managers chosen by the members. A manager may, but need not be, a member and has the authority to make business decisions and conduct the affairs of the LLC. This flexibility in determining management could allow a minority of members to retain control of the LLC. Issues concerning management and many other issues relating to the operation of the LLC may be determined through the adoption of the operating agreement.
Estate Planning: The LLC is an excellent estate planning tool as well. Gifts of economic increments can be conveniently made and, with a properly drafted operating agreement, substantial gifts can be made without loss of control. Because of discount valuation rules, a lower value may be claimed on the estate or gift tax return, allowing for a greater transfer of wealth with less gift or estate tax.
Why Have an Operating Agreement?The operating agreement is the agreement between the members and managers of an LLC. The operating agreement sets forth each member and manager’s rights and obligations with respect to the LLC and its assets. Generally, the operating agreement may contain any provision that is not contrary to law. While most states do not require an LLC to have an operating agreement, it is a mistake not to have one. The operating agreement helps in defending the limited liability protections, avoiding financial or management disagreements, and by making sure your business is governed by your rules and not the default rules of your state. In fact even if oral agreements exist among members, they will be overridden by state statute if not codified in a written operating agreement. If you are a SMLLC, the fact that you have a formal written operating agreement will lend credibility to your LLC's separate existence and help with liability protection.While it would take a book to discuss each of of these issues in depth, generally an operating agreement should address the following areas:
Income tax structure
Allocation of profits and losses
Limitations on the transferability of membership interests
Valuation of the company
Admission of new members
Duties of loyalty, non-competition, etc.
Events of dissolution
Dispute resolution procedures
ConclusionWhen organizing or re-structuring your business, many factors go into determining the right business entity to meet your needs. From ownership and management structure to tax structure, creating an LLC with the help of competent counsel can help you achieve varied business and estate planning goals while providing maximum flexibility.
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.