Ten Tips In Forming Limited Liability Companies

Rob Le ChevallierATTORNEY AT LAW

1. LLC’s are usually used for real estate holdings but more and more LLC’s are used for operating businesses.

a. Business LLC’s need to have special provisions.

b. Consider “guaranteed” payments in lieu of salaries and bonuses.

c. Provide for tax distributions to members.

d. Take a careful look at the authority of the manager and limit for major decisions and for borrowing authority.

2. For a client who has a lot of rental properties, I create a master LLC and separate subsidiary LLC’s for each property.

a. This has the advantage of separate liability shields for each property but one tax return and financial statement.

b. Avoid co-mingling of funds from each rental or provide for a property management account.

3. Default Rules: A single member LLC owned by an individual is treated as a sole proprietor for tax purposes. A single member LLC owned by a corporation is treated as a division of the corporation. Multiple member LLC’s are treated as partnerships for tax purposes. LLC’s can elect different tax treatment i.e. Sub S corporation by filing Form 8832.

4. Clients should be aware that active members of the LLC’s will pay self-employment tax on their earnings. Passive members (like limited partners) will not pay self-employment tax on their earnings.

a. The 3% Medicare tax can be significant for high earners who are over the social security limits.

b. Consider converting to S-corp or electing S-corp status as long as reasonable salary is paid.

5. Client must choose between a manager-managed LLC or a member-managed LLC. Even member-managed LLC’s often choose a managing member to act for the LLC. Managers do not have to be members of the LLC although they often are.

a. Manager-managed LLC’s are securities in Oregon; member managed LLC’s can be securities if members do not have effective control.

b. Review authority granted to manager or managing members.

6. LLC’s that are taxed as partnerships must maintain capital accounts and follow the capital account accounting requirements. This can become an issue when there are distributions disproportionate to the ownership percentages or units.

a. Avoid call provisions unless approved by the members or provisions in the operating agreement that require members to make up deficit capital account to limit liability to creditors.

7. LLC’s should have clearly drafted distribution provisions especially in a business LLC. The LLC should provide for sufficient distributions to pay taxes on the profits of the LLC so called “phantom income.”

a. This can be a significant issue where there are a lot of non-deductible expenditures such as insurance, inventory, travel and entertainment or large debt repayments of principal.

8. Some LLC’s provide for “guaranteed payments” similar to a draw or salary that are distributed before profits are distributed by units or ownership percentages. This is particularly true in a business LLC.

a. Bonus plans can also be structured as “guaranteed payments.

b. “Guaranteed payments” are made prior to any distribution based on percentages of ownership.

9. LLC’s should have buy-sell and valuation provisions in the event of withdrawal, death, disability, insolvency or expulsion. LLC’s usually require approval of the remaining members to admit a new member. Absent the approval of the remaining members, the new prospective members are assignees who have only an economic interest and no voting rights.

a. Valuation provisions are very important.

b. Provide discounts for early withdrawal.

10. LLC’s provide asset protection for two or more members because normally a court cannot compel distributions to the members except in accordance with the operating agreement.

a. In a single member LLC, a court can compel distributions to the single member.

b. Once the distribution is made creditors can reach the cash.

c. Even if profits are not distributed, member will receive allocation of taxable income on K-1.