This document was created as a short form reference to help our clients in Kentucky and Indiana for whom we have created a limited liability company and contains some generic information which may not specifically apply to your situation. It is not intended to be a complete and exhaustive treatise on the subject, nor to approach covering all the laws and regulations applying to this type of legal entity. It does, however, intend to give some basic information which I hope will be useful to you in keeping your business in compliance with basic formality requirements. Please remember that this is a relatively new type of legal entity with relatively little real case law or tax court history. We cannot guarantee how the courts or taxing authorities will treat you. We have even less ability to predict how courts of other states would treat you or what might happen if you alter the documents we have drafted or fail to follow the minimal business entity formalities outlined in your operating agreement and in this letter.
This letter highlights certain issues relating to the operation of your business that are important in realizing the limited personal liability and tax benefits of doing business in the limited liability company (LLC or PLLC, if a professional limited liability company) form.
1. BENEFITS OF LLC FORM
The limited liability and tax benefits of doing business in the LLC form result from the limited liability company being treated as a separate entity. To obtain these benefits, it is important that the LLC be operated as an entity separate from its members. In order to do this, you must understand the role of each of the persons involved in the operation of the LLC and must comply with certain formalities in operating the LLC. This is sometimes difficult to remember initially, if only one or two individuals are involved in the operation of the LLC.
2. SEPARATE ENTITY
It is critical that you recognize the LLC as a separate entity and treat it as such. Under no circumstances should LLC and personal funds, assets, or accounts be mixed. 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, or other distributions specifically approved in advance by the managers of the LLC. You will probably want your accountant to review this for you initially.
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, financial accounts, leases, orders, and other arrangements entered into by the LLC. It should also be used on all products, signs, advertisements, correspondence, business cards, office and telephone directory listings, and similar items. The LLC should carry its own insurance and will be required to file its own income and employment tax returns.
The LLC can only act through individuals or member entities. When acting for the LLC, however, remember that you are acting as a representative of the LLC, and not in your individual capacity. When signing documents, make it clear that you are acting in a representative capacity for the LLC. For example, all documents signed on behalf of the LLC by its members or managers should be signed, "[Name of LLC] by [Name of Member], Member." If you fail to make your representative capacity clear, you run the risk of incurring personal liability for the obligations of the LLC.
3. INDIVIDUAL ROLES
The members or managers of the LLC all have their own roles and functions, just like shareholders, directors, and officers of a corporation. It is important that these roles be kept separate and respected. This is particularly crucial in the case of a closely held LLC such as yours where the same individuals function in several different capacities. You may, for instance, want to review whether professional LLC members should have an employment agreement with the LLC.
The members own the LLC. However, the members are not partners in a partnership, and they neither own the business (which is owned by the LLC) nor necessarily manage the business (which is the function of the board of directors and officers). The members own an equity interest in the LLC typically defined by the "operating agreement" and have a voice in the management of the LLC since they elect the mangers of the LLC and participate in certain major decisions, such as sale of substantially all of the assets of the LLC and amendment of its articles of organization. If the LLC's existence is to be respected, it is important that the members' activities are limited to their proper role.
The members must act as a group. Actions should be taken at meetings, or by written consents signed by all members, through the adoption of formal resolutions. A formal written record of all actions taken by the members should be maintained in the LLC's minute book, just as with a corporation.
Although the law of this state does not require a written operating agreement or formal minutes and resolutions, experience with partnerships and corporations demonstrates this is the only way to keep track of the workings of the business entity. Perhaps just as significantly, the existence of this sort of written record of the meetings of the members or managers is likely to confirm the separate bona fide existence of the legal entity and that it is not merely an alter ego of the members, which could allow the shell to be pierced.
We recommend member meetings should be held at least once a year for the purpose of voting on certain ongoing matters of the business.
The LLC may be formed in such a fashion that it is run either by the members or by managers. The Articles of Organization will specify whether your LLC is run by members or managers. Managers may, of course be the members themselves. Special meetings may be required if additional matters requiring member approval arise.
4. LLC FORMALITIES
Because a LLC is a separate entity in which individuals may play a variety of roles, certain formalities are prescribed for LLC actions. Complying with these formalities is important to have the LLC recognized as a separate entity and to avoid personal liability for the obligations and liabilities of the LLC. The operating agreement of the LLC provides a guide to compliance with proper LLC formalities. In addition, proper and complete records must be maintained by the LLC.
A LLC is required by statute to keep certain records at its principal place of business. Subject to various statutes in different states, these would typically include: a current list of the full name and mailing address of all members and managers; a copy of the articles of organization and all amendments thereto; copies of the LLC’s federal, state and local tax returns and financial statements, if any, for the three most recent years, and if not prepared then the information needed to prepare them; a copy of any effective written operating agreement and all amendments. Additionally, unless contained in the operating agreement, there must also be on file written information setting forth the amount of cash, if any, and a statement of the agreed value of any other property or services contributed by each member and the times or events upon which additional contributions are to be made; and, finally, a written statement of the events upon which the LLC is to dissolve.
We suggest you put this document in your record book, for ease of reference in future. If we have not done so already, we can order you a bookshelf type formal record book for your business, with three ring binder, seal (required for some interstate transactions), tabbed dividers for your Articles, minutes of meetings, tickler, and other information. This may facilitate keeping your business entity records together and up to date. We can order one of these for you from a national suppliers of such materials at a nominal cost, or you can simply buy an inexpensive three ring binder to accomplish this.
b. Annual Report
A LLC, like a corporation, must file a written verification report with the Secretary of State on an annual basis (depending on state of organization and subject to regulations of states where it may be registered as a "foreign" business). This report gives current information about the registered agent, registered and principal office, names and addresses of the managers or members.
5. FURTHER ADVICE
You should seek further legal advice before undertaking major LLC changes or transactions. The LLC's operating agreement provides you with a guide to routine LLC operations, but additional guidance will be required to comply with the legal requirements for major matters.
The LLC form of business is typically selected because it can allow insulation from vicarious personal liability, similar to that of a corporation while allowing the members to be taxed as if in a partnership. Originally, and partially because LLCs were often created to take advantage of taxation on a basis similar to that enjoyed by partnerships, most state laws enabling the creation of LLCs provided that LLCs must have two or more members. This was similar to partnership laws and tax regulations. Now many states allow one member LLCs, in view of a change in position on this by the IRS. Since this is not accepted universally by all states, we still recommend forming and maintaining a LLC with at least two members. There are other matters which should have a written trail of documentation, for audit and other reasons.
Additionally, you should, for example, consult with us if you are considering any of the following:
(1) Doing business in a new state.
(2) Issuing membership interests or other debt instruments to investors.
(3) Selling or otherwise transferring a majority of the LLC's assets.
(4) Merging into any other LLC, or having any other LLC merge into the LLC.
(5) Having the LLC acquire assets from any member.
(6) Amending the articles of organization of the LLC.
(7) Dissolving the LLC.
Personal liability is always an issue with members of an LLC, just as it is with directors of a corporation. It is critical to remember that there is almost no case law or tax code history to rely upon with this entity. Analogizing the situation of a professional practice to an LLC, the Kentucky case of Boyd v. Badenhausen, 556 S.W. 2d 896 (Ky. 1977) could be the standard for personal liability. That case held that a physician in a professional service corporation was liable for the negligence of a clerical employee "under his supervision" who misplaced a file, even though the physician was not directly involved.
Avoiding vicarious liability does not necessarily mean avoiding supervisory liability. It probably does not mean avoiding typical tax or environmental liability either. The insulation from tort and contract liability, however, should be at least as great as with a corporation, but with partnership tax and flexibility benefits not available in an "S" corporation. Please consult closely with your accountants on financial transactions for your LLC, both in setting up your books and in transferring assets into or out of the LLC.
Please also keep in mind that we are performing specific and limited services for your new company. If for instance, we perform those specific services listed in "Package A," we probably are not registering your business with the state revenue agency or any of several local tax authorities with whom you should immediately register and to whom you will probably have to pay a license fee or owe a tax return. We are probably also not making a registration for unemployment insurance or workers compensation, unless you have specifically entered into an agreement in writing with us to do so.
There may be many filings, including licenses and permits which a new business must apply for in order to be in compliance with various law. We specifically are not doing this for you unless we have contracted in writing to do this for you or with you. Frankly, having us do many of these things is not very cost effective for you and this is a good opportunity to have you contact a good small business CPA to help you get your corporate books set up, develop a tickler of government reportings, such as withholding deposits, and other typical or unique nonlegal registrations, postings, filings, and reportings. We are typically taking you to the point of having a legal entity which can open its own bank account.
Unless contracted in writing in additions to services in Package A," we would, for instance if you were to open a bar and restaurant, not be assisting you in applying for a liquor license or obtaining Board of Health approval. These are your responsibilities by default, under our basic services package. We certainly will be happy to help you on any or all of these if you desire, or to try to recommend others who can assist you on such matters. Most people cannot effectively run a business by themselves. This is your opportunity to start building your typical "team" of attorney, CPA, insurance agent, financial advisor and others with professional and practical experience with a business, such as yours.
In addition, please feel free to contact me if questions arise regarding the day-to-day operation of your LLC. We have appreciated this opportunity to be of service to you and look forward to working with you in the future.