Is an LLC for you?

There’s a lot of advertising by companies that claim to protect your assets by forming a limited liability company for you. What’s the real story?. Two factors that I consider are (1) Does your business exposes its owners to significant liability and (2) Is there is more than one participant; that is, more than one owner or owner plus employees. If the answer to both is “yes,” then an LLC could shield you from liability caused by one of the additional parties.

IN GENERAL

An LLC is a form of business organization authorized by state law. It offers the limited liability of a corporation with the tax benefits of a partnership. So members of an LLC are only at risk for their investment in the LLC. A member can be sued for his own personal actions but cannot be sued for actions of the LLC or for other members or employees. The maximum amount a member can lose generally is the value of his investment in the LLC.  Unlike limited partners, a member who participates in LLC management will not lose his limited liability protection.

An LLC pays no income tax. It files a partnership tax return and income, deductions and credits are allocated among its members. Income, deductions, and credits of a one person LLC  are taxed to its member.

STRUCTURE

An LLC may have one or more members under Tennessee law. The LLC may be run like a partnership, like a corporation or like a limited partnership. It may be a group of members that decide by majority. The members may select a manager. The signature of the chief manager will bind the LLC unless otherwise provided. It may be managed by its members or by a board. Many rights and responsibilities can be changed in the Articles or Operating Agreement.

Members’ rights are divided into financial rights and governance rights. Financial rights include the rights to LLC profits, losses, and distributions. Governance rights are the right to control the LLC. Financial rights are freely assignable, but governance rights may not be assigned to other than existing members unless all  of the members and parties to contribution agreements consent to an assignment. Unless otherwise provided in articles or operating agreement, distributions of profits are allocated equally among the members and every member is an agent of the LLC for the purpose of its business contract.

HOW DO I CREATE AN LLC?

I bring an LLC into existence by drafting “Articles” and filing them with the Secretary of State along with filing fees of $300 and the County Register’s office, along with $7.00 filing fees. The Articles must set forth the name and address of the LLC and its registered agent, the original number of members, whether it is managed by members, manager or board and the duration of the LLC, if any. The LLC exists once filed with the Secretary of State.

I then draft the “minutes” of the organization of the LLC (record of the first meeting) approving the Articles and the Operating Agreement if any, appointing Managers, and approving other actions needed to get started.

If there is more than one member, I advise having an “Operating Agreement,” an extremely important document. An Operating Agreement is the “owners manual” for operating the LLC and avoids future disagreements. It governs the management of the LLC and the rights and privileges of its members. In my Operating Agreements I usually cover:

  1. The members and their interests;
  2. What each member contributes and its agreed value;
  3. The value and time of any contributions that a member has agreed to contribute or has the right to make;
  4. Any right of a member to receive or of the LLC to make distributions to a member;
  5. When the LLC shall be dissolved if unusual;Any other provisions required by law desired by the members.
  6. Any restrictions on the sale of members’ interests and what happens to a member’s interest on his death.
  7. An operating agreement that has been properly adopted is binding on the LLC, its members and any person or entity becoming a member or entering into a contribution agreement.

TAX ASPECTS

I have a one thousand page book on LLC taxation, so I can only mention the high points here. An LLC with more than one member is generally treated as a partnership for tax purposes, so it must file a partnership tax return, Form 1065.The IRS will automatically treat a one owner LLC as if it were its owner, so the owner files the LLC’s tax information on Schedule C of his personal tax return. In both cases, the LLC pays no federal taxes. Income, deductions, and credits of the LLC pass through to the members and are treated as if incurred directly by the members. For example, capital gain of the LLC becomes capital gain of the member.

The members have much flexibility in allocating profits, losses, and capital interests among themselves and can do so in their Operating Agreement. However, IRS rules require that such allocations have substantial economic effect, and certain transfers of property and cash between the members and the LLC can have tax consequences.

VERSUS S CORPORATIONS

I prefer an LLC over an “S” corporation. “S” corporations are likewise not subject to federal tax and pass tax items through to owners. S corporations are subject to Tennessee taxes. However, an S corporation  may not have a corporation or a partnership as a stockholder, but an LLC may have these entities members in an LLC.) In addition, S corporations are allowed to have only one class of stock. An LLC therefore  has more flexibility.

VERSUS PARTNERSHIPS

Unlike limited partners, members of an LLC may participate in its management. However, participation will generally mean that income is regarded as subject to self-employment tax.

VERSUS CORPORATIONS

Regular or “C” corporations are taxed separately from their owners for federal and state purposes, which means earnings are taxed once to the corporation and once to the shareholders.

TENNESSEE TAXES

In Tennessee, an LLC pays a $50.00 per member annual fee ($300 minimum). In addition, LLC’s are generally subject to Tennessee franchise and excise taxes. The excise tax is 6% of an LLC’s net earnings. The franchise tax is 25 cents per hundred dollars of the LLC’s net worth, ignoring debts and including the value of rental property used. There are exceptions but it is hard to meet an exception.

 

About Wis Laughlin

I help clients with tax preparation and IRS representation, estate planning, and complex contracts, including LLC's. As a former IRS tax attorney in their National Office. Law.com picked Wis in 2017 and several prior years as one of the Top Tax and Estate Lawyers in Tennessee. I am your advocate, not your accountant. I don't tell you what you can't do. I show you how to do it.
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