Limited Liability Company 101

OVERVIEW AND GENERAL FACTS OF AN LLC

The idea behind a Limited Liability Company is that it is a hybrid or a cross between a partnership and a corporation.  Limited Liability Companies were first developed in Wyoming in 1977 and spread to the rest of the United States during the 1990s.  They provided the limited liability of a corporation and the pass through taxation of a partnership.

The Limited Liability Xompany members can be active in the management of the LLC and not take on any personal liability as a result of the management activity.  The manager of an LLC can be a member if you choose, or the manager can be a non-member.  The members of an LLC can be natural people, other LLCs, or even trusts and corporations.

Limited Liability Companies can have a single member or multiple members.  Multi-member LLCs are stronger unless you live in a state that treats both single member and multi-member LLCs the same.

You can use your personal family Limited Liability Company to own businesses or personal assets.  It can just be used to hold a title to assets, if you choose, in order to keep the ownership of assets private and confidential.

TRICKS AND TREATS OF AN LLC

The members can have a voting interest or non-voting interest. This can be a powerful asset protection tool.  Most of our competition make all shares voting. However, if you decide to give the voting interest to only certain parties and the other parties have an economic non-voting interest, then this can enhance the asset protection features of the Limited Liability Company tenfold.

Income distribution is another secret of an LLC.  The members of an LLC can determine among themselves how to distribute LLC profits and losses.  Unlike a corporation where the profits and losses are fixed according to the percentage owned, in an LLC there is no such requirement.

An LLC can have a buy-sell agreement as part of the operating agreement.  This is a very powerful feature as it prohibits a creditor from gaining access even in the event of a charging order.  The buy-sell agreement kicks in on terms favorable to you.  Our agreements have this feature automatically built in.

An LLC can structure the operating agreement so that a creditor with a charging order still does not get anything.  The agreement can state that should any member get a charging order against them, then their interest will be held by the company for future distribution.

PLANNING WITH AN LLC

This is where the “Art of Estate Planning” comes into play.  Just forming an LLC and getting a good operating agreement is not the end of the road.  In fact, that is just the beginning.  The next steps are to decide how to use the LLC in your overall business and personal asset protection and estate planning structure.  

Deciding on the ownership of the LLC is just an example.  Who will own it and who will manage it?  Will it be owned by you, some form of revocable or irrevocable trust, another LLC or a corporate entity?  The list of possibilities is endless and that is where we come in.  We can assist your structure of your LLC for maximum estate planning and asset protection efficiency.

Many clients decide on some sort of multiple LLC and trusts structures that give the greatest possible benefits for privacy, asset protection, and planning.  A client of ours recently brought us a document that he received from the FDIC in settlement of money owed.  The FDIC had 5 layers of LLCs formed for both ownership and management.  If it is good enough for the government, then it should also be good enough for you!

TAXATION ISSUES OF AN LLC

The tax nature of a Limited Liability Company is one of many areas where they shine. Unlike C corporations which have double taxation, a Limited Liability Company does not.  The profits and losses of the Limited Liability Company pass through to its members and they report the income on their personal tax returns. The LLC pays no federal income taxes. If a Limited Liability Company is owned by a single member or by a husband and wife in a community property state, then the IRS considers the LLC to be a disregarded entity for tax purposes.  So, no tax return needs to be filed.  An LLC can also elect to be taxed as a partnership, a C corporation, or as an S Corporation.  There are many possibilities. This is an area where your tax advisor can assist you.

In 1987, the IRS decided that in order to be taxed as a partnership and not taxed as a corporation, the articles must show that the company possesses no more than two of the following four characteristics (which describe a corporation):

Perpetual Existence

Centralized Management

Free Transferability of Ownership Interest

Limited Liability

However, in 1997 the IRS revised its ruling and stated that any non-corporate entity could self-classify for federal tax purposes.

STEPS TO SET UP AN LLC

Setting up an LLC is relatively simple.  It is a matter of filing the proper paperwork with the Secretary of State’s officer where the LLC is to be located. In some cases, the Secretary of State’s pre-printed articles are filed, and in other cases custom articles are filed. A name is required, as well as a resident agent.  The resident agent is the representative for the LLC in the state where the entity is formed.  If you live in the state of formation, then you can be your own resident agent.  If not, then we provide a resident agent for you.  The resident agent is also the entity that receives and accepts any lawsuits that are filed against the Limited Liability Company.

Limited Liability Companies do not have perpetual existence, (see the taxation section) so usually a time period of around 30 to 50 years is put in the articles.  However, they can always be renewed when the time period is up, as long as your operating agreement allows for it.  Our does allow for renewal upon expiration.

THE IMPORTANCE OF A GOOD OPERATING AGREEMENT OF AN LLC

An operating agreement is a very essential part of forming an LLC.  Frequently people form LLCs without one or they get a quickie agreement with limited pages which addresses few of the important issues. Some operating agreements now being offered by the discount LLC formation services actually allow creditors to attach the assets of the members.  Others allow the creditors to attach the member’s ownership in the Limited Liability Company.   There is one case of an operating agreement purchased through the major discount LLC formation company that had conflicting clauses in the operating agreement for the members.  When the members got into a disagreement, they had to go to court and that one single inconsistent paragraph ended up costing one of the members several million dollars.

It is simply as case of “You get what you pay for.”

Some of the basics of an operating agreement are listed below, and then some of the unique and custom features we provide are listed in the Section 2.

Basics – Section 1

  • Who are the members.
  • How they will be elected.
  • Termination of members and how to do it.
  • Allocation of business shares after the death of a member.
  • If a member becomes disabled, how will the company provide for him/her (with disability insurance or out of its own funds)?
  • How managers will be selected and what their duties, salaries, and grounds for dismissal will be.
  • How major decisions will be made. (Which decisions will require unanimous approval of the members and which a simple majority vote? Which decisions can be delegated to the manager in charge of daily affairs?)
  • How often meetings will be held.
  • Who will keep records and how they will be kept.
  • How members will invest in the LLC: will only cash contributions be allowed or can members contribute services as well?
  • How profits and losses will be allocated.
  • How compensation (salary) for actively participating members will be determined.
  • How new capital should be acquired.
  • What procedures must be followed to transfer interests in the company.
  • Penalties, if any, if members or managers fail to act in accordance with the operating agreement.

Advanced – Section 2

What are some of the features of our operating agreement?  Well, see below.

First of all, it’s important to understand why an operating agreement is critical when using a LLC or a FLP in your asset protection planning.  You see, LLC and FLP are partnerships in their legal sense.  Assets inside the LLC/FLP are not owned by individual partners separately but by the entire partnership as a whole by agreement, hence the operating agreement, or — formally called — the partnership operating agreement.  The fact that the LLC and FLP are partnerships is what makes them such ideal entities for asset protection.  

When there is not a written operating agreement among the partners, there simply is no formal partnership.  Just because you register a LLC or a FLP in your state doesn’t mean that you have a real partnership when it comes to protecting your assets.

If your LLC/FLP is ever challenged in court, the first thing the opposing legal counsel and the judge will ask for is your operating agreement.  If you don’t have one, it’s likely that the judge will disregard your LLC/FLP as just an extension or alter ego of the owners.   Even if you have an operating agreement, you want to make sure that it’s really doing what you want, which is, asset protection, rather than running a business.  An operating agreement that’s drafted for someone to run a business will actually do more harm than good to your asset protection plan.

Many customers ask about our operating agreement. They have checked into the discount services available and find that the operating agreements are either nonexistent or very poorly drafted. What do we offer that the competition does not?  Here are just a few examples:

  • We list the business purpose of your LLC or FLP.  We list over 15 business reasons why your entity was formed.
  • We list all of the business activities that your entity may engage in.  This keeps a creditor from saying that you just formed it for asset protection purposes.
  • We state why the company has built-in restrictions among the members such as capital contributions and ownership transfers.  This keeps a judgment creditor from claiming the restrictions are pure punitive in nature.
  • We have Mandatory Capital Contribution clauses at the discretion of the manager.
  • We list extensive accounting issues and tax issues to keep a creditor from causing dissolution of the company due to their actions.
  • We limit distribution of profits or assets to frustrate creditors’ attempts to force distribution.
  • Restrictions regarding charging orders.  No distributions can be made to any member whose interest has been charged by a charging order. (Most competitor agreements DO NOT provide this!)
  • Members cannot be forced to return a distribution in order to satisfy a creditor.
  • Manager is given full authority and broad powers to manage the company.  No creditor can claim he does not have the authority to make decisions.
  • Certain decisions require the unanimous consent of the members so that a creditor cannot force changes that are not to the benefit of the company and its members.
  • If any member is under court order, his vote does not count towards the total of votes needed to pass a decision.  
  • A creditor cannot force the removal of a manager.
  • A manager can file for personal bankruptcy and still not be removed by a creditor.
  • No creditor can force a distribution of assets to themselves.
  • No creditor can force a partition of assets to themselves.
  • No member, who gets a charging order against himself, can force a distribution or partition of assets.
  • No member, assignee, or creditor can force a dissolution of the company.
  • Creditors do not have the right to vote on many important issues.
  • A charging order does not allow the creditor to become a member of the LLC or FLP.  
  • No member’s interest can be assigned to a creditor.
  • If a creditor tries to force the LLC or FLP to pay them the amount owed by the charging order and the member’s interest so charged, the LLC or FLP has 30 years to pay. Requirements to get to this state are exhaustive and difficult.

The purpose of the operating agreement is to have a clear understanding between the partners at the time the LLC or FLP is formed.  It is to have all parties agree to the terms and conditions.  If an outside creditor tries an attack on a member’s interest, then the agreement makes it very difficult, if not impossible, for that creditor to ever get a viable interest in the entity.