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Operating Your Newly Formed Limited Liability Company (LLC) - Cincinnati Corporate Tax
This letter highlights certain issues relating to the operation of your limited liability company (LLC) that are important in realizing the limited personal liability and tax benefits of doing business in the form of an LLC.
1. BENEFITS OF LLC FORM
As we discussed when you formed your LLC, doing business in the form of an LLC provides limited liability for all owners (“members”) and permits the LLC flexibility in its taxation strategy. These are significant benefits as compared with other forms of structuring a business entity. However, to gain that limited liability protection or experience the advantages of some taxation strategies, the LLC must be treated as a separate entity from its members and be operated in accordance with its operating agreement and/or the governing statutes.
2. SEPARATE ENTITY
In order to obtain limited liability for the LLC’s members, it is critical that each member recognize the LLC as a separate entity and treat it as such. Under no circumstances should personal funds, assets, or accounts be mixed with LLC funds, assets, or accounts. LLC funds should not be used to pay personal expenses, to make personal investments, or for any other purposes not related to the LLC's business. LLC assets should be distributed to members only in the form of compensation, distributions to pay income taxes, or other distributions specifically approved in advance by the members.
It is important that the LLC initially be given sufficient assets of its own to provide it with a reasonable chance of being successful in its business. The assets contributed initially should not be withdrawn prior to the dissolution of the LLC if the result of the withdrawal would be to leave the LLC too undercapitalized to continue its business.
The LLC should also be held out to third parties as a separate entity. All business of the LLC should be conducted in the name of the LLC, and the name of the LLC should be used on all agreements, contracts, leases, orders, and other arrangements entered into by the LLC. It should also be used on all products, signs, advertisements, correspondence, business cards, telephone directory listings, and similar items. The LLC should carry its own insurance and will be required to file income and employment tax returns. Be mindful that although the LLC may be managed by its members in a manner similar to a partnership and taxed as a partnership, the LLC should not hold itself out as a partnership, or else its members may incur personal liability. To that end, be sure the owners of the company are referred to as “members,” and not as “partners.”
The LLC can only act through individuals. However, when acting for the LLC, remember that you are acting as an agent of the LLC, and not in your individual capacity. When signing documents, make it clear that you are acting in an agency capacity for the LLC. For example, all documents signed on behalf of the LLC by a member should be signed, "[Name of LLC] by [Name of Member], Member,” if member managed, or “[Name of LLC] by [Name of Manager], Manager,” if manager-managed. Note that the LLC is member-managed unless the members choose to be manager-managed in an executed operating agreement. If a member fails to make his agency capacity clear, he runs the risk of incurring personal liability for the obligations of the LLC. Keep in mind, however, that members will remain liable for acts of personal malfeasance, especially if such conduct is wanton or reckless.
3. THE IMPORTANCE OF AN OPERATING AGREEMENT
In order to protect a member's limited liability, it is important that, if the LLC has an operating agreement, the LLC be operated in accordance with such terms. You should refer to the operating agreement periodically to be sure that LLC operations are being conducted properly. Unless you chose to be manager-managed in an operating agreement, the LLC is member-managed, and each member has the ability to act on behalf of the company and bind the LLC to contracts. If one of the members is not actively participating in the business, having the LLC manager-managed may provide the membership with significant tax advantages, and more sound succession options.
Among other things, the operating agreement probably provides that the members should hold a member meeting whenever a decision requiring the consent of the members is to be made. Acts and decisions requiring the consent of members usually include: changing the nature of the business of the LLC; incurring of indebtedness or selling assets outside the ordinary course of business of the LLC; entering into a transaction involving a conflict of interest with a member; making optional distributions to members; and deciding to continue the LLC following the death, incompetence, withdrawal, expulsion, bankruptcy, or dissolution of a member. A permanent written record of the meeting should be created that indicates, who was present at the meeting, the action taken at the meeting, and the number of members voting in favor of or against matters coming before the meeting.
The records of the meetings should be kept at the principal place of the LLC's business. A record of the names, addresses, and ownership interests of members, a copy of the operating agreement, and financial records of the LLC should also be maintained at the principal place of the LLC's business. Moreover, if the operating agreement provides for the recording of annual minutes, or any formal notices or waivers by members, then the company should ensure that such are recorded and remain readily accessible to the members.
The operating agreement may contain restrictions on the transfer of members' interests. Members may be required to follow a specific process if they want to transfer their interests to others. Furthermore, approval by all the members is generally required to admit a new member to the LLC.
The operating agreement may also contain provisions regarding the effect of the death, succession, incompetence, withdrawal, expulsion, bankruptcy, or dissolution of a member. These provisions should be consulted if any of these events occur. If the LLC does not have an operating agreement, the members will need to consult your attorney to determine the current law regarding your particular situation. You should note particularly that prompt action may be required to prevent dissolution of the LLC following the occurrence of one of these events.
4. FURTHER ADVICE
The company should seek further legal advice before undertaking major changes or transactions affecting the LLC. The members should, for example, consult with us if they are considering any of the following:
(1) Doing business in a new state.
(2) Admitting one or more new members.
(3) Selling or otherwise transferring a majority of the LLC's assets.
(4) Merging into any other LLC or other entity, or having any other LLC or other entity merge into the LLC.
(5) Having the LLC acquire the interest of any member.
(6) Amending the operating agreement.
(7) Dissolving and winding up the LLC.
If the company does not have an operating agreement, it may consider obtaining one because it allows the members to determine for themselves what the agreement among the members will be, and not rely on change state and case law. Please share this letter with all members of the LLC and make sure that every one is on the same page. This will also allow all members to assess whether any additional actions are needed. In addition, please feel free to contact us at (513) 731-6601 if questions arise regarding the day-to-day operation of your LLC. We have appreciated this opportunity to be of service to you and look forward to working with you in the future.
If you have any questions, please direct them to William E. Hesch Law Firm at (513) 731-6601.