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.

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.

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 The assets contributed initially should not be withdrawn prior to the dissolution of the LLC if the result of the withdrawal would be to leave the LLC too undercapitalized to continue its business.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.

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, incomp