Guide to Operating a Limited Liability Company | Legal Form Articles

Limited liability companies are a relatively new form of business organization, first recognized in the United States by the State of Wyoming in 1977. Since then, legislation has been enacted in all 50 states and the District of Columbia (Washington D.C.) to allow businesses to organize as limited liability companies. A limited liability company is a separate legal entity, as is a corporation. The business structure is actually a hybrid type of business entity–between a corporation and a partnership. It is organized in a fashion similar, but not identical to, that of corporations. It also offers owners the limits on personal liability that previously were only available to shareholders in corporations. The owners (or members) of a limited liability company are, like the shareholders of a corporation, not liable for the debts and obligations of the company beyond their actual contributions to the company. In addition, in most cases, if it is organized properly, it is taxed at the federal level as a partnership, or even possibly as a sole proprietorship. This means that there will only be one level of taxation. The profits and losses of the company are passed through to the individual owners, in the same manner as in the taxation of partnerships. Corporations, on the other hand, are subject to a double taxation–first at the corporate level and then an additional tax at the individual level, after corporate profits in the form of dividends are passed on to shareholders.

Another flexibility that limited liability companies are afforded is the ability to distribute profits and losses to its members in any proportion that they choose. For common corporations, this flexibility is not present. Shareholders in corporations do not share directly in the profits or losses of the corporation. They only receive dividends if so decided by the directors of the corporation. S-type corporations pass through their profits and losses to the shareholders, but are generally restricted to dividing the profits and losses on the basis of percentage of ownership of each individual shareholder. Limited liability companies have the greater flexibility to choose to distribute their profits and losses in any manner that they wish, regardless of the percentage of ownership of the members. There are a few restrictions on such distributions, however, if a limited liability company is to be treated as a partnership for federal tax purposes. They must abide by two particular partnership distribution rules: that the distribution allocations must have some “substantial economic” relation to the actual economic risks or rewards of the members and that the members may be subject to income tax on their contribution of future services to the limited liability company. If you wish the manner in which your limited liability company distributes its profits and losses to its members to deviate far from the actual proportionate contributions of its members, a competent tax professional should be consulted to avoid any problems.

The limited liability company also offers management possibilities that are more flexible than those of either corporations or limited partnerships. These unique characteristics make this form of business operation one of the fastest growing forms of organization. Many of the actual operational characteristics of limited liability companies are set by what are termed default rules, that are rules that are set by statute in each state. A default rule is essentially a rule that governs the affairs of the company, unless the rule has officially been changed by the company in its official documents. Thus, in all states, there are certain rules that will govern the limited liability company but there is also, in all states, a manner by which a limited liability company can change these rules. Thus, by creatively using the formation and operating documents of the limited liability company, members may choose to operate the limited liability company in a wide variety of manners. How these default rules come into play as you plan your limited liability company will be examined below.

Organization of a Limited Liability Company

Limited liability companies are, in some ways, organized in a manner similar to corporations. The shareholders of a corporation have their counterpart in limited liability companies as its members. These members are the owners of the company, in much the same way that shareholders are the actual owners of a corporation. Most states now allow a limited liability company to be formed by one member and that member need not always be a natural person. (Note: one-member limited liability companies are generally taxed as sole proprietorships, not partnerships). One of the management capabilities of a limited liability company is that the members may choose to manage the company themselves or they may select managers to manage the company. Most states have a default rule that the members are the managers of the company. This is unlike corporations, in which the shareholders elect the directors, who in turn, select the officers of the corporation, who then manage the company. In limited liability companies, the members may either remain as the managers or they may select managers to run the company. If management is desired by managers, these managers may either be members of the limited liability company or they may be non-members. In addition, the managers of a limited liability company need not necessarily be natural persons, unlike the requirement that corporate directors must be natural persons. This affords the limited liability company a flexibility of management styles that is not available in other forms of business.

To obtain more information about Articles of Organization, pre-organization activities, and other similar forms, please click on the appropriate link below:

Articles of Organization
Similar to a corporation, there are two initial forms that outline the actual operation of the limited liability company. The first is known in most states as the Articles of Organization. A few states refer to this central organizing document by another name–for instance, Washington state calls it a Certificate of Formation. For ease of understanding, the title Articles of Organization will be used throughout this discussion. (Please check our State Law Digest for Limited Liability Companies to verify the particular usage in your own state.) This form parallels, in many ways, the function of the Articles of Incorporation of the business corporation. Its function is to provide the state with information regarding the framework of the business. All states require that it be filed, generally with the Secretary of State or a similar state agency. There will be a filing fee for such filing, that may range from $40 to upwards of $500, depending on your particular state. In addition, some states base this fee on the capitalization of the company, generally charging more for companies with capitalization of over $50,000. Finally, there may be an additional initial fee charged for an annual or biennial report for the company. These are generally in the $100 range. For details of the fee requirements for your state, check the State Law Digest.

Each state also has requirements that certain information be provided in the Articles of Organization. This is to enable the state to keep tabs on specific information regarding the company. Most states also require that such information be updated on a regular basis, annually or biennially. In general, the basic requirements for information are similar to that required of corporations. Most states do not require all of the information listed below to be provided. Some states require a bare minimum of information. Many states will also provide a pre-printed fill-in-the-blanks Articles of Organization form, although, in general, the use of these forms is not mandatory. A very few states, notably Arizona and New York, also require that notice of filing the Articles of Organization be published in a newspaper. Please note that you should see your state’s entry in the State Law Digest included with the purchase of a LLC form from www.findlegalforms.com to check on the specific requirements. Following is a list of most of the basic information requirements for Articles of Organization:

Name of the company
Duration of the company, if less than perpetual
Purpose of the company
Registered agent’s name and address
Initial member’s name and addresses
Any reservation of the right to admit new members
The right of the company to continue business following an act of dissolution
Whether the company will be managed by members or managers
Manager’s names and addresses, if managed by managers
Contributions of members to the company
Future contributions required of members to the company

To purchase one of the forms discussed in this section or to obtain more information about Articles of Organization, Articles of Incorporation, and other similar forms, please click on the appropriate link below:

Operating Agreement
The second important document for a limited liability company is the Operating Agreement. This document is the limited liability company equivalent of a set of corporate bylaws. Within this document, the basic rights and responsibilities of the members or managers are defined. If matters relating to these areas are not covered by an adequate Operating Agreement, the state’s default rules will, generally, take effect. It is within the Operating Agreement that the limited liability company management structure will be decided; that the division of profits and losses will be laid out; that the member’s contributions of money, services, or property will be defined; and that member’s voting and other rights will be laid out. This document is the key to the success of the limited liability company and must be prepared with care and foresight.

To purchase one of the forms discussed in this section or to obtain more information about Operating Agreements, corporate bylaws, and other similar forms, please click on the appropriate link below:

Management
Basically, there are three methods by which a limited liability company can be managed. By members only, by members and non-members, or by only non-members. The reasons for selecting each of these methods is set out below:

Management by Members Only
This is, by far, the most common approach taken to managing a limited liability company. Most small business owners prefer to take the hands-on approach and manage their own companies. However, if there are a large number of members of the limited liability company, this approach can become unwieldy. It is possible under this approach that not all members will manage the company; that some of the investing members will choose that the company be run by other members. However, even non-voting/non-managing members of a member-managed limited liability company will be considered to have earned the profits of the company and thus, they will be required to pay personal income tax on any limited liability company income that passes to them. However, there is a special tax situation that may arise regarding those members who do not participate in the management of the company. They may avoid paying self-employment taxes on their share of the company profits if they work for 500 hours or less at the company’s business. If one or more of your members fall into this category, a competent tax professional should be consulted. In addition, in limited liability companies that are managed entirely by members and all members participate, the ownership interests in the limited liability companies are generally not considered to be securities under state and federal law. This eliminates an enormous amount of paperwork and regulation from the operation of the member-managed limited liability company. In most situations, this will be the management style with the most flexibility.

Management by Members and Non-member Managers
It is possible to run a limited liability company by a combination of members and non-members. This choice may be appropriate for limited liability companies that desire to have an outsider (non-member) with particular expertise participate in the management decisions. For any number of reasons, the non-member manager may be desired: so that all profits are passed only to members, so that all losses are only sustained by members, or any other reasons specific to your particular business situation. Again, there is a special tax situation that may arise regarding those members who do not participate in the management of the company. They may avoid paying self-employment taxes on their share of the company profits if they work for 500 hours or less at the company’s business. If one or more of your members fall into this category, a competent tax professional should be consulted. Finally, the ownership and transfer of membership interests in a limited liability company that is managed, even in part, by managers may possibly subject the limited liability company to regulation under state and federal securities laws. If you choose this type of management structure, a competent tax professional should be consulted.

Management by All Non-member Managers
Although this type of management style is possible, it is chosen in relatively few companies. This style may be chosen if the members have little or no expertise in the particular business and desire a skilled manager or management team to handle the all affairs of the business. Again, for this form of management, there is a special tax situation that may arise regarding members who do not participate in the management of the company. They may avoid paying self-employment taxes on their share of the company profits if they work for 500 hours or less at the company’s business. Finally, the ownership and transfer of membership interests in a limited liability company that is managed solely by non-member managers may possibly subject the limited liability company to regulation under state and federal securities laws. If you choose this type of management structure, a competent tax professional should be consulted.

To obtain more information about the management of limited liability companies, please click on the appropriate link below:

Limited Liability Company Existence
As noted already, a limited liability company is a separate legal entity that offers its members a manner by which to assure that the personal assets of the owners are not at risk in the business. In a sole proprietorship or partnership, an owner’s personal property and real estate can be reached by creditors and courts to fulfill the legal obligations of the business. For corporations and limited liability companies, this is generally not true. Special care must be taken at the time of formation of the business to be certain as to when this limit on liability comes into effect. States have several different general times when the limited liability company is officially formed for the purposes of determining liability. In general, a limited liability company is formed when either:

Its Articles of Organization are filed with the state
Its Articles of Organization have been approved by the state
The Articles of Organization have been approved by the state, but may be made
retroactive to the date of original submission
The company has chosen to delay the date of effectiveness to a later date than
the filing or approval of the company’s submission of the Articles of Organization

If your company will be involved in an enterprise that will have potential liability immediately upon formation, it will be wise to understand the particulars of your state’s rules in this area. Please check the State Law Digest for information on your state.

To obtain more information about Articles of Organization, pre-organization activities, and other similar forms, please click on the appropriate link below:

Division of Profits and Losses
As noted earlier, one of the principal flexibilities of the limited liability company is the ability to structure the division of profits and losses to members in any reasonable manner. Members may be provided their distribution of profits and losses in direct proportion to their contributions of money, services, or property to the company. This, in fact, is most often the clearest method by which to structure distribution. However, this form of business entity allows endless possibilities to tailor such distributions to the circumstances of your business. If a member is contributing a particular expertise, they may be compensated by a greater percentage of share in the profits of the business. If a member chooses not to participate in the management of the company, those members who do manage may earn a greater percentage share in the profits and losses. Look closely at your particular business organization and contributions to decide the fairest manner in which to distribute the proceeds or losses of the limited liability company.

Voting Rights of Members
The default rules that are in effect in most states provide that a member’s right to vote is allocated in proportion to the member’s contributions to the limited liability company. A few states provide that member’s voting rights are per capita, in other words, each member gets one vote only. In some states, managers are also given one vote in the affairs of the company. State default rules also typically provide that limited liability company matters be decided by either a majority or unanimous vote of the members. In all states, the Operating Agreement of the company may override most of these provisions and provide for voting divisions in any proportions desired, including denying voting rights to certain members. However, in many states, the default rules may not be overridden with regard to decisions on major company matters, such as the sale of all company assets, the dissolution of the company, or amendments to the Operating Agreement or Articles of Organization. Also note that in order to place any such restrictions in the Operating Agreement or Articles of Organization, it will be necessary to abide by the state default rules in order to adopt the original version of each document. Please consult the State Law Digest for the situation in your particular state.

Membership and Management Meetings
Most states do not require regular membership or management meetings. However, it is often prudent for the members and/or managers to meet at least on an annual basis to review the conduct of the company and plan for the future. In addition, meetings may be necessary more often in order to handle major affairs of the business that are beyond the scope of the managers alone, such as dissolving the company.

To obtain more information about member meetings, or other similar forms, please click on the appropriate link below:

Member Meetings Kits

Member and Manager Liability to Others
One of the most important benefits of forming a limited liability company is that the owners are not personally liable for any debts or obligations of the company -search more about Whitney S. Boan, P.A- Every state statute has this provision included in it. In addition, many states also extend such limited liability to others in the company, such as employees, non-member managers, and agents of the company. However, please note that anyone who is shielded from personal liability for the normal debts and obligations of a company, whether they are directors of a corporation or members of a limited liability company, are not shielded from personal liability for their own negligence, recklessness, or criminal activity, they would have to hire help from a Criminal defense law firm in Stuart in this case. Please check the State Law Digest included with your purchase of a form from www.findlegalforms.com for information on the rules regarding the limits of the liability shield in your state.

Additional Default Rules
Each states’ statute regarding limited liability companies contains additional default rules that will apply to your limited liability company unless it is officially altered in either the Articles of Organization or the Operating Agreement. Each state may have a different version of each of these rules. Please check the State Law Digest included with the purchase of a form from www.findlegalforms.com entry for your state, and for criminal cases you can get criminal appeals counsel here. These rules generally cover the following items:

Continuity of the company: This default rule states whether or not the company will be automatically dissolved if a member withdraws from the company.
Transferability of Interests: This default rule governs the ability of a member to transfer their ownership interest in the limited liability company to another person, by gift, sale or otherwise. Most states require either a majority or unanimous vote of the members in order to obtain consent to transfer an limited liability company ownership interest.
Operating distributions: The method by which operating distributions are to be distributed to the members of an limited liability company are noted under this default rule in most states. The variations on this particular rule are distribution on a per-capita basis, distribution on a proportionate basis based on each member’s contribution, or distribution on a per-profit share basis.

Taxation of Limited Liability Companies
In general, the owners of limited liability companies have a choice regarding how they are to be taxed. If the company has only one member, it will be treated as a sole-proprietorship for federal tax purposes, unless the member-owner elects otherwise. Being taxed as a sole proprietorship means that all of the profits and losses of the company will be reported on the member/owner’s personal income tax return, using Schedule C of IRS Form 1040. The single-member limited liability company may, however, choose to be taxed as a corporation by filing Federal IRS Form 8832: Entity Classification Election, and selecting “A domestic eligible entity electing to be classified as an association taxable as a corporation.” If the company makes this election, the company must file a normal corporate tax form: IRS Form 1120, and pay corporate income tax on any profits.

If the limited liability company has two or more members, it will be taxed as a partnership under IRS rules, unless it elects to be taxed otherwise. Being taxed as a partnership means that all of the profits and losses of the company will be passed through to the members in the proportion determined by the Articles of Organization or the Operating Agreement of the company. This pass-through will be reported on Schedule K-1 of IRS Form 1065: U.S. Partnership Return of Income. A multiple-member limited liability company may also, however, choose to be taxed as a corporation by filing Federal IRS Form 8832: Entity Classification Election, and selecting “A domestic eligible entity electing to be classified as an association taxable as a corporation.” If the company makes this election, the company must file a normal corporate tax form: IRS Form 1120, and pay corporate income tax on any profits.

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