Forming an LLC for Your Business Entity

Guide to LLC for Sacramento Area Businesses

Although it is sometimes referred as a corporation, technically, a Limited Liability Company, or LLC, is not a corporation.  An LLC is probably best described as a combination of certain aspects of a corporation and a partnership. That is, an LLC entity can provide similar asset protection to that of the limited liability of a corporation. Simultaneously, the LLC often allows for more flexibility in the management of the business and organization. However, there are certain important tax considerations that must occur to maintain full compliance with the law. An LLC does not pay any income tax itself. It’s a “flow through” entity that allows profits and losses to flow through to the tax returns of the individual members. Avoiding the double taxation of C-Corporations. While setting up an LLC can be more difficult than creating a partnership (or sole proprietorship), experienced CPAs and financial professionals can walk you through the process.

Who Should Form an LLC?

One of the most common reasons for forming an LLC is to insulate your personal finances and assets from business liabilities. For instance, if you decide to open a retail business that deals directly with the public, you may worry that your commercial liability insurance won’t fully protect your personal assets from potential slip-and-fall lawsuits or claims by your suppliers for unpaid bills. Running your business as an LLC may help you sleep better. Doing so will permit you to rest easily knowing that even if an accident or business downturn does occur, then your personal savings and residence will not be impacted in most cases. Not all businesses can operate as LLCs, however. Businesses in the banking, trust, and insurance industry, for example, are typically prohibited from forming LLCs. We can provide guidance regarding whether an LLC is appropriate for your company and its goals.

Exceptions to Limited Liability Protection

Like shareholders of a corporation, all LLC owners are protected from personal liability for business debts and claims. The importance of a limited liability structure most commonly comes into play when the business is unable to pay its bills and falls behind on its debts. If the business is not incorporated or organized in a form that provides limited liability protection, then creditors may seek to satisfy the debt by repossessing a member’s personal assets such as a home, car, or other possessions. When there is limited liability protection, these personal assets cannot be pursued by creditors. While LLC owners enjoy limited personal liability for many of their business transactions, it is important to realize that this protection is subject to certain exceptions. An LLC owner can be held personally liable if he or she:

• Personally and directly injures another person.
• Personally guarantees a bank loan or a business debt on which the LLC defaults.
• Fails to properly handle employment or trust fund taxes withheld from employee paychecks.
• Intentionally engages in fraudulent or illegal behavior.
• The owner or responsible party treats the LLC as an extension of his or her personal assets, rather than as a separate legal entity.
• The responsible party commits defalcation or another violation of his or her fiduciary duty.

The last two exceptions are the most important. In some circumstances, a court might say that the LLC doesn’t really exist and find that its owners are really doing business as individuals, who are personally liable for their acts. To keep this from happening, make sure you and your co-owners:

• Act fairly and legally. Do not conceal or misrepresent material facts or the state of your finances to vendors, creditors, or other outsiders.
• Fund your LLC adequately. Invest enough cash into the business so that your LLC can meet foreseeable expenses and liabilities.
• Keep LLC and personal business separate. Get a federal employer identification number, open up a business-only checking account, and keep your personal finances out of your LLC accounting books.
• Create an operating agreement. Having a formal written operating agreement lends credibility to your LLC’s separate existence.

Additional Guidance Regarding Protecting Your Personal Assets

A well-suited and carefully selected liability insurance policy can protect your personal assets even when the entity’s limited liability protection does not. For instance, if you are a massage therapist and you accidentally injure a client’s back, your liability insurance policy should cover you. Insurance can also protect your personal assets in the event that your limited liability status is ignored by a court. In addition to protecting your personal assets in such situations, insurance can protect your corporate assets from lawsuits and claims. Be aware, however, that commercial insurance usually does not protect personal or corporate assets from unpaid business debts, whether or not they’re personally guaranteed. Also, most insurance policies will specifically exempt coverage for certain types of claims.

Should I Form an LLC or an S Corporation?

While the S corporation’s special tax status as a pass-through entity eliminates double taxation, it lacks the flexibility of an LLC in allocating income to the owners. For one, an LLC is permitted to issue numerous classes of stock conferring different rights and responsibilities. Furthermore, while there are limitations on the total number of shareholders in an S Corporation, there is no limit on LLC members.  Your organizational goals must be assessed and weighed before selecting a corporate form.

What is an LLC Operating Agreement?

An LLC operating agreement is the founding and fundamental organizational document that allows you to structure your financial and working relationships with your co-owners. In your operating agreement, these and other basics should be defined:

• You and your co-owners should establish and set forth each owner’s percentage of ownership in the LLC.
• Owners’ right to his or her share of profits (or losses) should also be set forth.
• Owner and manager rights and responsibilities should also be set forth. It is also wise to define processes and procedures that will apply when a member underperforms or fails to perform.
• Defining what will happen should a member wish to step away from the business can minimize the potential for disputes

Essentially, a well-drafted operating agreement will address many of the day-to-day managerial decisions and processes that an organization must define.

Must I Hold LLC Meetings?

Although a corporation’s failure to hold shareholder or director meetings may subject the corporation to alter ego liability, this is not the case for LLCs in many states. In California, for example. an LLC’s failure to hold meetings of members or managers is not usually considered grounds for imposing the alter ego doctrine provided that the LLC’s Articles of Organization or Operating Agreement do not expressly require such meetings. Understanding the steps your company is required to engage in is an essential part of management.

Work with Experienced CPAs and Accountants when Forming an LLC

If you are looking to take your business to the next level, considering organizing as an LLC may be your next step. If your business has grown or undergone other changes, it may also be wise to reconsider whether its current form of organization is amenable to your goals. To schedule a free initial consultation, please call 916-432-2218 or contact us online.