Form Your Own Limited Liability Company

by Mancuso, Anthony; Lawrence, Beth; Lawrence, Beth

• ISBN13: 9780873377973
• ISBN10: 0873377974
• Edition: 3rd
• Format: Paperback
• Copyright: 2002-01-01
• Publisher: Nolo

Summary

In Form Your Own Limited Liability Company, readers find the step-by-step instructions and forms they need to create an LLC in their state, without the expense of hiring a lawyer.

This bestseller covers how to:
-- choose a valid LLC name
-- prepare and file Articles of Organization
-- set up a member-run or manager-run LLC
-- take care of ongoing legal and tax paperwork

The 3rd edition has been revised to reflect the latest federal regulations as well as each state's laws. Provides all necessary forms -- with instructions to fill them out -- as tear-outs and on CD-ROM.

Author Biography

Tony Mancuso is a California attorney and the author of Nolo's best-selling corporate law series, including Incorporate Your Business: A 50-State Legal Guide to Forming a Corporation and How to Form Your Own California Corporation. Tony authored Nolo's The Corporate Minutes Book and Your Limited Liability Company: An Operating Manual, national titles on holding meetings, preparing and maintaining corporate and LLC records and taking care of important ongoing corporate and LLC legal and tax business. He is also the author of How to Form a Nonprofit Corporation, a national title that provides forms and instructions for forming a nonprofit corporation in each state and line-by-line instructions for obtaining tax-exempt 501(c)(3) status with the IRS. He is the programmer and author of Nolo's LLC Maker program, an interpretive Windows software product that produces the forms to organize a limited liability company in each state. Tony is a jazz guitarist and a licensed helicopter pilot.

Table of Contents

Introduction
Who May Form an LLC?	2	(1)
How to use this Book	3
Overview of the LLC
Development of the LLC	2	(1)
LLCs at a Glance: The Best thing Since Sliced Bread?	2	(3)
Which Businesses Would Benefit as LLCs?	5	(1)
Comparison of LLCs and Other Business Forms	6	(11)
Business Entity Comparison Tables	17
Basic LLC Legalities
Number of Members	2	(1)
Paperwork Required to set up an LLC	2	(1)
Responsibility for Managing an LLC	3	(5)
Member and Manager Liability to Insiders and Outsiders	8	(2)
Are LLC Membership Interests Considered Securities?	10
Tax Aspects of Forming an LLC
Most LLC Owners Prefer Pass-Through Tax Status (Or Sole Proprietorship Status for a Sole-Proprietor)	2	(1)
How LLCS Report and Pay Federal Income Taxes	3	(1)
LLCS and Self-Employment Taxes	4	(1)
State Law and the Tax Treatment of LLCs	5	(2)
Other LLC Formation Tax Considerations	7
How to Prepare LLC Articles of Organization
Read State Sheets and Order LLC Materials	2	(3)
Review and Organize Your State's LLC Information	5	(1)
Choose a Name for Your LLC	5	(8)
Check Your State's Procedures for Filing Articles	13	(1)
Prepare LLC Articles of Organization	13	(12)
Finalize and File Your Articles of Organization	25	(2)
What to do After Filing Articles of Organization	27
Prepare an LLC Operating Agreement for Your Member-Managed LLC
Scope of Our Basic LLC Operating Agreements	2	(2)
Modifying Your LLC Operating Agreement	4	(1)
How to Prepare a Member-Managed LLC Operating Agreement	5	(31)
Distribute Copies of Your Operating Agreement	36
Prepare an LLC Operating Agreement for Managers
Choosing a Manager-Managed LLC	2	(2)
How to Prepare an LLC Management Operating Agreement	4	(23)
Distribute Copies of Your Operating Agreement	27
After Forming Your LLC
If You Converted an Existing Business to an LLC	2	(4)
Basic Tax Forms and Formalities	6	(2)
Ongoing LLC Legal Paperwork and Procedures	8	(9)
Other Ongoing LLC Formalities	17
Lawyers, Tax Specialists and Legal Research
Finding the Right Tax Advisor	2	(1)
How to Find the Right Lawyer	3	(3)
How to do Your own Legal Research	6
APPENDIX A State Sheets
APPENDIX B Tax Regulations
Revenue Ruling 88-76	2	(5)
IRS ``Check-the-Box'' Tax Classification Regulations	7

Excerpts

Overview of the LLC

A. DEVELOPMENT OF THE LLC 1/2

B. LLCs AT A GLANCE: THE BEST THING SINCE SLICED BREAD? 1/2 1. Limited Liability Status 1/3 2. Business Profits and Losses Taxed at Individuals' Income Tax Rates 1/3 3. Flexible Management Structure 1/3 4. Flexible Distribution of Profits and Losses 1/4

C. WHICH BUSINESSES WOULD BENEFIT AS LLCs? 1/5 1. Businesses That Benefit from the LLC Structure 1/5 2. Businesses That Should Normally Not Form an LLC Using This Book 1/6

D. COMPARISON OF LLCs AND OTHER BUSINESS FORMS 1/6 1. Sole Proprietorship 1/7 2. General Partnerships 1/8 3. C (Regular) Corporations 1/10 4. Limited Partnerships 1/13 5. S Corporations 1/15

E. BUSINESS ENTITY COMPARISON TABLES 1/17

In this chapter, we briefly trace the history of the limited liability company (LLC), discuss its legal and tax characteristics and compare it to the traditional ways of organizing and doing business in the U.S. We'll delve more into the specific legal and tax characteristics of LLCs in the next two chapters.

If you are familiar with LLCs. If you have followed the development of the LLC over the last few years and know its general legal and tax characteristics (or you simply want to look at the specifics of forming an LLC right now), you can skip the introductory material in this and the following two chapters. Move right ahead to Chapter 4, where you'll learn how to prepare LLC articles of organization.

A. Development of the LLC

The LLC is a relatively recent version of a type of business organization that has existed for years in other countries. It resembles the German GmbH, the French SARL and the South American Limitada forms of doing business, all of which allow small groups of individuals to enjoy limited personal liability while operating under partnership-type rules (rather than the complex rigmarole that applies to corporate-type structures).

The Wyoming legislature enacted the first state LLC legislation in 1977, eventually followed by Florida in 1982. In those early days, this new type of business entity was a risky proposition, because no one knew whether the IRS would tax an LLC as a corporation or a partnership. Because the idea behind forming an LLC-to enjoy the tax status of a partnership without the legal liabilities-seemed almost too good to be true, few business people were brave enough to avail themselves of this new business model without clarification from the IRS. Similarly, other states were unwilling to jump in with LLC legislation of their own.

The first big break in the LLC stalemate came in 1988, when the IRS ruled on the tax treatment of Wyoming LLCs in Revenue Ruling 88-76. (A copy of this ruling is in Appendix B.) To the surprise of many tax practitioners, the IRS agreed that an LLC formed under the Wyoming statute was eligible for partnership tax status. The IRS's nod of approval created huge amounts of enthusiasm for LLCs, ultimately resulting in all states plus the District of Columbia passing LLC legislation.

The second big break came on January 1, 1997 when the IRS threw out its old, and unnecessarily complicated, business entity tax classification regulations and agreed that LLCs should be taxed as partnerships (or sole proprietorships if they have one owner) without jumping through a number of technical hoops. Moreover, the IRS now lets an LLC elect corporate tax treatment if it wants it (by filing IRS Form 8832-see Chapter 3).

B. LLCs at a Glance: The Best Thing Since Sliced Bread?

In the U.S., the LLC stands as a unique alternative to five traditional legal and tax ways of doing business: sole proprietorships, general partnerships, limited partnerships, C (regular) corporations and S corporations. The business press has heralded the arrival of the LLC with enthusiasm and hyperbole. Finally, you can establish a business entity with the limited liability of a corporation while retaining a level of tax simplicity that resembles a partnership. Is this fanfare justified? In large part, we think so, at least for smaller startup businesses and existing partnerships. It doesn't often happen that a new business form comes along, particularly one that is blessed by the IRS with the favorable tax ruling bestowed upon the LLC.

1. Limited Liability Status

The legal characteristic most interesting to the business world is undoubtedly the limited liability status of LLC owners. With the exception of corporate entities, the LLC is the only form of legal entity that lets all of its owners off the hook for business debts and other legal liabilities, such as court judgments and legal settlements obtained against the business. Another way of saying this is that an investor in an LLC normally has at risk only his or her share of capital paid into the business.

2. Business Profits and Losses Taxed at Individuals' Income Tax Rates

The LLC is recognized by the IRS as a "passthrough" type of tax entity. That is, the profits or losses of the LLC pass through the business and are reflected and taxed on the individual tax returns of the owners, rather than being reported and taxed at a separate business level. (Other pass-through entities include general and limited partnerships, sole proprietorships and S corporations-those that have elected S corporation tax status with the IRS. A detailed discussion of pass-through taxation is in Section D, below.)

3. Flexible Management Structure

LLC owners are referred to as members. A member may be an individual or, generally, a separate legal entity, such as a partnership or corporation. Members invest in the LLC and receive a percentage ownership interest in return. This ownership interest is used to divide up the assets of the LLC when it is sold or liquidated, and is typically used for other purposes as well-for example, to split up profits and losses of the LLC or to divide up its voting rights.

LLCs are run by their members unless they elect management by a management group, which may consist of some members and/or nonmembers. Small LLCs are normally member-managed-after all, most small business owners want and need to have an active hand in the management of the business. However, this isn't always true. Especially with a growing business or one that makes fairly passive investments, such as in real estate, investors may not want a day-to-day role. Fortunately, an LLC can easily adopt a management-run structure in situations such as these:

• the members want the LLC to be managed by some, but not all, members

• the members decide to employ outside management help, or

• the members choose to cater to an outsider who wishes to invest in or loan capital to the LLC on condition that he or she be given a vote in management.

4. Flexible Distribution of Profits and Losses

Business owners may want flexibility in how they split their profits and losses. An LLC allows you to decide what share of the LLC profits and losses each owner will receive. Rather than being restricted to dividing up profits proportionate to the members' capital contributions (this is the standard legal rule for corporations), you may split up LLC profits and losses any way you wish (this flexibility is afforded partnerships as well).

Example: Steve and Frankie form an educational seminar business. Steve puts up all the cash necessary to purchase a computer with graphics and multimedia presentation capabilities, rent out initial seminar sites, send out mass mailings and purchase advertising. As the traveling lecturer, cash-poor Frankie will contribute services to the LLC. Although the two owners could agree to split profits and losses equally, they decide that Steve will get 65% for the first three years as a way of paying him back for taking the risk of putting up cash.

By contrast, rules governing the distribution of corporate profits and losses are fairly restrictive. A regular (C) corporation cannot allocate profits and losses to shareholders at all-shareholders get a financial return from the corporation by receiving corporate dividends or a share of the corporation's assets when it is sold or liquidated. In an S corporation (a corporation that has made a special tax election with the IRS, covered in Section D5, below), profits and losses pass through to the owners and profits and losses generally must follow shareholdings. For example, an S corporation shareholder holding 10% of the shares ordinarily must be allocated a 10% share of yearly profits and losses.

There are a few wrinkles in the flexibility afforded to LLCs. Because LLCs are treated like partnerships for tax purposes, LLCs must comply with technical partnership tax rules:

• Special (disproportionate) allocations of LLC profits or losses are subject to rules that require such allocations to have "substantial economic effect." Generally, they must reflect some economic reality of the business-for example, the member with the greater share of profits should also be at risk for a greater share of losses. Rather than squabble with the IRS on this issue, LLCs that make special allocations usually have their tax advisor add technical provisions to their operating agreement to make sure their allocations will be respected by the IRS. (See the discussion in Chapter 3, Section D2.)

• Members contributing future services to the LLC may be subject to income taxes on the value of their services. A member promising to contribute services to the LLC may face personal income tax liability on the value of those services- although there are some ways around this. (We'll have more to say about the tax problems associated with a member's contribution of services in Chapter 3, Section D1.)

C. Which Businesses Would Benefit as LLCs?

Here is an overview of the types of persons and businesses for which the LLC form makes the most and least sense. Bear in mind that this discussion is not meant to be set in stone-certainly you may find that your business breaks the mold.

1. Businesses That Benefit From the LLC Structure

LLCs generally work best for:

• Actively run businesses with a limited number of owners. Owners numbering between one and about 35 keep the logistics of making collective business decisions manageable. With the LLC form, all owners of the business enjoy limited liability and the flexibility of pass-through (partnership) tax treatment.

• Small startup companies. New businesses generally wish to pass possible early-year losses along to owners to deduct against their other income (usually salary earned working for another company or income earned from investments).

Continue...

Excerpted from Form Your Own Limited Liability Company by Anthony Mancuso Copyright © 2001 by Anthony Mancuso
Excerpted by permission. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.

THERE'S NEVER LIMITED LIABILITY FOR PERSONALLY GUARANTEED DEBTS

No matter how a small business is organized (LLC, corporation, partnership or sole proprietorship), its owners must normally co-sign business loans made by banks-at least until the business establishes its own positive credit history.

When you co-sign a loan, you promise to voluntarily assume personal liability if your business fails to pay back the loan. In some cases, the bank may ask you to pledge all your personal assets as security for repayment of the guaranteed loan; in others, it may require you to pledge specific personal assets-for example, the equity in your home-to secure repayment of the loan.

Example: A married couple owns and operates Books & Bagels, a coffee shop cum bookstore. In need of funds (dough, really) to expand into a larger location, the owners go to the bank to get a small loan for their corporation. The bank grants the loan on the condition that the two owners personally pledge their equity in their house as security for the loan. Because the owners personally guaranteed the loan, the bank can seek repayment from the owners personally by foreclosing on their home if Books & Bagels defaults. No form of business ownership can insulate them from the personal liability they agreed to.

If you want more information about pledging personal assets to secure business loans, see The Legal Guide for Starting and Running a Small Business, by Fred Steingold (Nolo).

UNIFORM LLC LAWS

For many years, legal scholars and state legislators have worked hard to have all states adopt the same (or very similar) laws affecting key areas of American business and life. A bit belatedly, efforts are being made to adopt a national model LLC act that can be used by individual state legislatures to pass future LLC legislation. One model is the Prototype Limited Liability Company Act, sponsored by the American Bar Association's Section of Business Law. Another is the Uniform Limited Liability Company Act, developed by the National Conference of Commissioners on Uniform State Laws.

Both of these acts are still in development, and there is justified skepticism as to whether states will replace current LLC laws with either model act. More likely, states probably will adopt portions of the model acts to supplement their current LLC statutes. In short, while LLC laws are fairly similar (they generally try to conform to IRS regulations and to LLC statutory schemes in other states), state-by-state differences are likely to remain.