1. What is a Limited Liability Company? A limited liability company or “LLC” is a business entity that is designed to offer co-owners of a business who make a proper filing with the state, freedom from personal liability for the debts of the business, the debts of each partner, the option to manage the business and the tax advantages obtained through the use of partnership status. The owners enjoy limited liability so that they are not personally liable for business obligations. By contrast, sole proprietors and partners in general partnerships are each liable for all of the debts of the business. The LLC can be member-managed or manager-managed. The LLC combines the best attributes of a corporation (protection and succession) and a partnership (tax benefits).
2. How do you form an LLC? In Virginia an LLC is formed by filing “Articles of Organization,” with the State Corporation Commission. The Articles of Organization are normally provide very basic information with respect to the name of the company, the agent for service of process, the company’s address, and its manager(s) or member(s).
3. How is a LLC Structured? An LLC is structured much like a partnership, with the owners being referred to as members instead of partners. The LLC can be member-managed in a manner similar to a general partnership or it can be manager-managed like a general partner does in a limited partnership. If the LLC is member-managed all members will typically have an equal vote and collectively make decisions. This includes not only major business and financial policies but also everyday operations. If the LLC is manager-managed, the members only decide on major financial and business decisions and the manager handles the day-to-day business operations. An LLC may also be structured to provide benefits and equity interests to children and to provide estate tax discounts and succession planning in family businesses.
4. How is the structure of the LLC determined? The founding members of the LLC determine the structure by means of an Operating Agreement which is similar to a partnership agreement. Typically, when the Articles of Organization are filed, the state requires the articles to include the management structure and define whether the LLC is member-managed or manager-managed. The members will then have an experienced attorney draft an Operating Agreement which sets forth the different rights and responsibilities of the members and covers matters such as capital contributions, division of profits, management, member meetings, transferability of ownership interests, dissolution, and indemnification.
5. What are fees for establishing and operating a LLC? Forming an LLC is an investment in your business. The amount of the investment varies between states and also depends upon the type and complexity of the business being established through the LLC. In Virginia, the costs of setting up an LLC will include a registration fee with the Virginia State Corporation Commission (currently $100) and may include attorney fees, paying an accountant, and deed preparation among others. The total cost of establishing an LLC is totally dependent upon each situation and the professionals that are involved.
6. Tax and Accounting Treatment: Recent changes in federal tax law – known as the “check-the-box” regulations – have allowed LLCs to choose between taxation as a partnership and corporate taxation. In most instances it is better to be taxed as a partnership. When electing to be taxed as a partnership the LLC files an informational tax return and issues K-1 statements to its members. The K-1 shows the member’s share of the income or loss incurred by the LLC, all of which flows through to each member’s personal tax return. If the LLC is taxed like a partnership or S Corporation, the LLC will not pay “corporate income tax.” If the LLC is a single member LLC, the owner may treat it as a disregarded entity for tax purposes and report the tax and related accounting on the individual tax return of the member. This eliminates the necessity of filing a tax return for the LLC.
7. Charging Order Protection: Creditors are normally restricted to obtaining relief against members of an LLC through what is known as a charging order. This means that the creditor can get an order requiring the LLC to pay the creditor any distributions that would otherwise be made by the LLC to the judgment debtor member whose interest is being charged. This remedy precludes a judgment creditor of a member from obtaining a seizure and forced sale of the debtor-member’s interest in the LLC. The charging order remedy is often times the exclusive remedy available to the creditor and provides substantial asset protection for LLC owners.
A charging order limits the creditor exclusively to collecting income or distributions which the LLC assets might provide to a member, but under most circumstances the LLC manager has discretion and can choose to withhold such distributions. Stated another way, a creditor who has obtained a charging order only has the right to receive distributions from the entity when and if such distributions are made to the members, even though the LLC itself may have substantial income.
8. Holding Real Estate in the LLC: If the primary purpose of the LLC is to hold title to real estate investments the members will need to deed or convey the real property to the LLC by means of a formal, recorded deed. All of the rents with respect to the real property should be deposited in the LLC bank account and all expenses with respect to the property should be paid from the LLC bank account. All contracts with respect to the real property and service arrangements should be exclusively in the name of the LLC.
9. Examples: The following are some examples of when and why a LLC might be wisely selected:
- Jean Simon is a widow who in addition to her residence owns a four-plex in Chesapeake, Virginia. She is concerned about potential liability above and beyond her insurance coverage and has elected to place the four-plex into an LLC of which she is the single member. She treats it as a disregarded entity for tax purposes and all of the tax and accounting are reported on her individual tax return.
- Dave Carson, his brother Bill and their friend, Richard, each own a one-third interest in a small shopping center in Virginia Beach, Virginia. They have created an LLC in which to hold title to the shopping center so as to protect their respective personal assets from any claims with respect to the shopping center. All three of them participate equally in the LLC which is member-managed by the three of them and they treat it as a partnership for tax purposes. The LLC files a partnership return; Dave, Bill and Richard each receive a K-1, which they use to prepare their individual tax returns.
- Ron Tolberg, owns a 25% interest in a 76 unit apartment building which he manages in Norfolk, Virginia. The other 75% is owned by various members of Ron’s family and by some friends. Ron and the other members have placed the apartment complex into a manager-managed LLC to provide Ron greater flexibility in his management duties and responsibilities. The LLC reports its taxes as a partnership and Ron and all the other members receive K-1s for their shares of profits. Ron also receives a salary or guaranteed payment as manager which is paid to him as an expense before there is a division of profits.
- LLCs can be used to operate any retail or other business in situations where limited liability and the flexibility of the LLC is desirable.
Establishing an entity for your business requires that a number of management and tax issues are addressed in each unique situation. For that reason, you should always engage the services of an attorney to determine which, if any, legal solutions are right for you.
This article is intended only for the purpose of providing general information and does not constitute legal advice. By providing this information we are not establishing an attorney-client relationship and anything contained in this article should be construed to necessarily be applicable to your unique situation.
© Davis Law Group, P.C. 2014