Nolo’s Plain 4th (2007)

4th Edition by Attorney Anthony Mancuso Nolo’s Quick LLC FOURTH EDITION FEBRUARY 2007 Editor LISA GUERIN Production JESSICA STERLING Co v er Photography TONYA PERME (www.tonyaperme.com) Proofreader RO BERT WELLS Index SONGBIRD INDEXING SERVICES Printer DELTA PRINTING SOLUTIONS, INC. International Standard Serial Number (ISSN) 1932-17401 ISBN 1-4133-0565-2 Copyright © 2000-2007 by Anthony Mancuso. All Rights Reserved. Printed in the USA. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise without prior written permission of the publisher. Reproduction prohibitions do not apply to the forms contained in this product when reproduced for personal use. Quantity sales: For information on bulk purchases or corporate premium sales, please contact the Special Sales department. For academic sales or textbook adoptions, ask for Academic Sales, 800-955-4775. Nolo, 950 Parker St., Berkeley, CA 94710. Acknowledgments A special thanks to Ilona Bray, Bethany Laurence, and Jake Warner for help producing the first edition, and to all the Noloids at Nolo for their continued assistance in helping me keep alive another self-help law business resource. Table of Contents I Introduction Should You Consider Forming an LLC? 3 How to Use is Book 9 What is Book Doesn’t Do 10 Legal and Tax Experts 10 Other Nolo LLC Resources 10 1 An Overview of LLCs Basic LLC Features 16 Exceptions to Owners’ Limited Liability 25 Basics of Forming an LLC 34 2 e LLC vs. Other Business Structures Other Business Structures 43 What Is a Sole Proprietorship? 44 What Is a General Partnership? 49 What Is a Limited Partnership? 54 What Is a C Corporation? 57 What Is an S Corporation? 68 What Is an RLLP? 73 Deciding Between an LLC and Another Business Type 76 Business Structures Comparison Table 79 3 Members Capital and Profits Interests LLC Capital Interests 86 Tax Considerations of Start-Up Capital 87 Converting an Existing Business to an LLC 95 Profit and Loss Interests 96 Special Allocations of Profits and Losses 98 4 Taxation of LLC Profits Pass-rough Tax Treatment 102 How LLCs Report and Pay Federal Income Taxes 108 Electing Corporate Tax Treatment 110 LLC Owners and Self-Employment Taxes 114 5 LLC Management Member vs. Manager Management 118 Legal Authority of LLC Members and Managers 122 Member and Manager Meetings 123 Member and Manager Voting Rights 126 6 Starting and Running Your LLC: e Paperwork Paperwork Required to Form an LLC 130 Ongoing LLC Paperwork 142 Securities Filings 150 7 Getting Legal and Tax Help for Your LLC Getting Legal Help for Your LLC 162 Getting Tax Help 170 Appendixes Appendix A: State Information 173 Appendix B: Sample Operating Agreement 181 Appendix C: Checklist for Forming an LLC 197 Index Introduction Should You Consider Forming an LLC? 3 How to Use is Book 9 What is Book Doesn’t Do 10 Legal and Tax Experts 10 Other Nolo LLC Resources 10 2 | NOLO’S QUICK LLC In the business world, limited liability companies are seen as the latest hot thing. e limited liability company (LLC) is a relatively new business ownership structure that combines the best features of the corporation and the partnership. It gives small business owners corporate-style protection from personal liability while retaining the pass-through income tax treatment enjoyed by sole proprietorships (the legal term for one-person businesses) and partnerships. Protection from personal liability—often referred to as “limited liability”—means that creditors of the business cannot normally go after the owners’ personal assets to pay LLC debts and claims arising from lawsuits; pass-through tax treatment means that business profits are reported and taxed on the individual income tax returns of the business owners. I’ll discuss limited liability and pass-through taxation in much more depth in Chapter 1. All 50 states and the District of Columbia now allow people to form this unique type of legal and tax entity, and most make it easy, convenient, and even relatively economical for small businesspeople to create and register an LLC. For these reasons, more and more entrepreneurs are choosing to organize their businesses as LLCs. And there have been two recent developments that have added fuel to the LLC fire: • All states no w permit the formation of single-o wner LLCs. is means that a person who has done business in the past as a sole proprietor (or is just starting out) can now protect his or her personal assets from business debts and claims by filing some simple paperwork and forming an LLC. • e IRS no w allo ws LLCs (including single-owner LLCs) to choose between pass-through taxation and corporate tax treatment. Although most LLC owners will decide to stick with pass-through tax status (paying tax on their individual income tax returns), they INTRODUCTION | 3 can also elect to be taxed as a corporation, splitting business income between the business and their own personal income tax returns, which can lower overall business income taxes. As you’ll see in Chapter 4, income splitting can make sense for LLCs that make more than the owners want to take out of the business or that need to retain substantial profits on a regular basis. For me, the most convincing evidence that the LLC has indeed caught on as a popular small business legal entity is the fact that, almost every day, I notice more small businesses with the telltale “LLC” tag at the end of their business names. If you doubt this, just enter any big office building and look at the directory of tenants: You’re bound to notice a good sprinkling of LLC business names along with the traditional “Inc.” and “Corp.” designators. Should You Consider Forming an LLC? Forming a new business as an LLC is an easy, quick, and relatively inexpensive way for new business owners to operate a business with limited liability while paying taxes on their individual income tax returns. Likewise, converting an existing sole proprietorship or partnership to an LLC is an easy way for sole proprietors and partners to protect their personal assets without changing the income tax treatment of their business. But this doesn’t address the larger question: Does it make sense for you to form your new business as an LLC, or, if you’re already in business, to convert your existing business into an LLC? Unless you have already incorporated or you run a microbusiness that has little chance of incurring debts or liabilities, my answer is simple: Yes, you probably should form an LLC. Here’s why: Forming an LLC is very easy—you just fill in a standard form provided by most state LLC filing offices and file it, usually for a modest filing fee. And in exchange for your small efforts, you will receive a big legal benefit—your personal assets will be protected from business debts and claims, without making your taxes more complicated. 4 | NOLO’S QUICK LLC A few examples help to illustrate when it does and doesn’t make sense to form an LLC: ExamplE 1: Sam sets up a music store to sell guitars, keyboards, and musi- cal accessories. Because members of the public will enter his retail space, Sam has opened himself up to various types of legal exposure (slip-and- fall lawsuits, for example). In addition, he knows that it’s easy to become enmeshed in contract disputes with suppliers and customers (for example, buyer’s remorse can often set in shortly after the purchase of a pricey guitar or synthesizer). Even though Sam will carry a reasonable amount of com- mercial liability insurance and do his best to keep his customers satisfied, he sensibly decides that it makes sense to file LLC articles of organization with his state for a $125 fee, so he can take advantage of the extra personal security that limited liability protection affords. Sam’s state, like many oth- ers, also charges a $50 annual report fee each year, but aside from this small amount and the few minutes it takes to complete the simple one-page annual filing form, there are very few added costs or burdens associated with doing business as an LLC. And Sam knows that by forming an LLC instead of operating as a sole proprietor, he won’t get a different tax status, as he would if he elected to form a corporation (the other legal entity that provides all of its owners with limited personal liability for business debts). ExamplE 2: Stella and Vera have operated a pet grooming business from rented quarters in a strip mall for several years. eir partnership has been successful, and they’ve managed to increase their profits every year. Of course, there have been small problems with the occasional fussy pet own- er—and they were sued once in small claims court for a poodle dye-job that went slightly awry—but no big lawsuits or other major legal hassles. However, as profits have grown, so too have its owners’ worries about their business. ey are a lot busier than they used to be, and have had to hire several employees. ey know that although most of their employees are well trained, expensive mistakes can happen, especially when new people are hired. Stella and Vera have also begun to worry about employee law- suits. If the owners have to fire someone, will the employee go quietly or hire a lawyer and make their lives miserable for a while? [...]... are not the only helpful products on the market—they’re just the ones I know best (after all, I wrote or created most of them!) All are available at Nolo’s website (www.nolo.com) • LLC or Corporation, by Anthony Mancuso This companion to Nolo’s Quick LLC explains in detail the technical legal and tax differences between LLCs and corporations It also provides detailed information on the legal and tax consequences... State LLC Laws 35 How to Form an LLC .37 14 | nolo’s quick LLC T he LLC is a relatively new and highly popular alternative to the five traditional ways of doing business: as a sole proprietor, a general partnership, a limited partnership, a C (regular) corporation, and an S corporation In this book I’ll explain not only how LLCs work and why so many small business people are... previously required technical hoops And even better, the IRS decided to give LLC owners the flexibility to change their tax status by electing corporate tax treatment if they wish (Chapter 4 explains this option.) 16 | nolo’s quick LLC Number of Owners (Members) Contrary to what you may have read just a few years ago, you can now form an LLC with just one person in any state (or the District of Columbia)... the owners pay tax on money the corporation pays them Without going into the details, it’s safe to say this means more bookkeeping, more accounting, and more complexity (I explain corporate taxation in detail in Chapter 2.) 22 | nolo’s quick LLC TIP An LLC can elect to be taxed as a corporation While most new LLCs will not choose to do so, a few will find that being taxed as a corporation actually reduces... as a tearout form—you simply check the appropriate options, then fill in the blanks • Tax Savvy for Small Business, by Frederick W Daily This book gives LLC owners information about federal taxes and explains how to make the best tax decisions for your business, how to maximize profits, and how to stay out of trouble with the IRS ● 1 C H AP T E R An Overview of LLCs Basic LLC Features ... management protections and controls as corporations, such as shareholder inspection rights and annual disclosure requirements, which makes it more difficult for investors to hold management accountable  | nolo’s quick LLC In addition, it’s more difficult to set up different classes of ownership in an LLC to cater to the special concerns of investors In contrast, in a corporation, the founders can adopt... and then get back to business And, let’s be honest—if you are going to spend leisure time curled up with a book, I’m sure you can think of several with better plot lines and character development 10 | nolo’s quick LLC What This Book Doesn’t Do You can’t form an LLC using this book alone Its goal is to provide a good overview of the subject, no more So if you already know a good deal about LLC legalities... simply not on the hook for debts the business cannot repay They’ll be able to go back to their unforeclosed-upon houses, reapply for their day jobs, and start building their dreams and fortunes again 18 | nolo’s quick LLC TIP Commercial insurance doesn’t cover business debts While commercial insurance can protect a business and its owners from some types of liability (for instance, slip-and-fall lawsuits),... can expect to receive a percentage of the current value of the LLC that corresponds to his or her capital interest percentage—a 25% member can expect to be paid 25% of the current value of the LLC 20 | nolo’s quick LLC Example 2: Tasty Treats, LLC, is a neighborhood bakery owned by Ned, Sylvia, and four of their relatives Only Ned and Sylvia work in the bakery The LLC issues a total of 600,000 membership... capabilities, rent out initial seminar sites, send out mass mailings, and purchase advertising As the traveling lecturer and student pied piper, cash-poor Frankie will only contribute services to the LLC (As explained in Chapter 3, Frankie will have to pay income tax on his one-half capital interest because it’s a form of payment for his services.) Although the two chapter 1 | An Overview of LLCs | 21 owners . Running Your LLC: e Paperwork Paperwork Required to Form an LLC 130 Ongoing LLC Paperwork 142 Securities Filings 150 7 Getting Legal and Tax Help for Your LLC Getting Legal Help for Your LLC 162 Getting. an LLC 197 Index Introduction Should You Consider Forming an LLC? 3 How to Use is Book 9 What is Book Doesn’t Do 10 Legal and Tax Experts 10 Other Nolo LLC Resources 10 2 | NOLO’S QUICK LLC In. Duty to the LLC 27 Losing Your Limited Liability 31 When Personal Creditors Can Go After LLC Assets 32 Basics of Forming an LLC 34 What Types of Businesses Can Form LLCs? 34 State LLC Laws 35 How