The 101 on LLCs: An Overview of Forming, Operating, and Dissolving an LLC

The 101 on LLCs: An Overview of Forming, Operating, and Dissolving an LLC

The 101 on LLCs: An Overview of Forming, Operating, and Dissolving an LLC

Every business owner is faced with the decision of how to structure his or her company. Around the world, the options generally include business structures such as a sole-proprietorship, Limited or General partnership, or corporation.

These all come with their own set of advantages and disadvantages. But in the United States, there’s a popular option that often offers the best of all worlds: a limited liability company, or LLC.

What is an LLC—and why is it such a popular business structure?

Two of the most attractive benefits a business structure can offer are limited liability and pass-through taxation.

  • Limited liability means that a person’s financial liability is limited to person’s investment in a company. For example, if someone sues a business with limited liability, they can generally only sue the company, not its owners or investors. Investors or owners won’t have to pay out-of-pocket to cover lawsuits or other debts. However, investors may lose the value of their shares or investment in the company
  • Pass-through taxation means that any taxes on the income of a company are paid by another entity or person, usually the business owner(s), and not by the company itself. The income, expenses, deduction, credit, and related taxes “pass through” the company and onto someone else. This protect the entity from double taxation.



Various business entities can have either of these benefits—but rarely both. For example:

  • C corporations have limited liability, but not pass-through taxation.
  • Limited and General Partnerships, on the other hand, have pass-through taxation, but not limited liability.

In the past, only two business entities had both limited liability and pass-through taxation: S corporations and limited partnerships (LPs). But each of those had their own disadvantages.

  • S corporations only exist under federal tax law, not state law. They’re also limited in the number and types of owners they can have—usually 100 or less of only U.S. citizens or residents aliens, NO Foreign Persons, corporation , or partnership shareholders.
  • Limited partnerships do not offer 100% limited liability. At least one general partner must be responsible for debt obligations under state law. Management participation of limited partners is also typically prohibited or heavily restricted.

But then the LLC appeared and solved all of these problems in one business structure. LLCs:

  • Allow the complete pass-through taxation
  • Offer the operational flexibility of a partnership
  • Provide 100% liability limited to the owners’ investment
  • Have no restrictions on the number or types of members
  • Allow all members to participate in management

In short, they offer essentially all of the advantages of other business entities without the major drawbacks of any. They’re the complete package, the best of all worlds.

Until 1990, Wyoming and Florida were the only states in the U.S. to recognize LLCs. Now, all 50 states and Washington, D.C. recognize them. They’re a legitimate business structure under the Internal Revenue Code, and they’re popular for business owners across America, and the world at large.



How to Form an LLC

Like corporations, LLCs are legal entities created under state law. Most states allow an LLC to form for any lawful purpose. In order to transact business in a given state, an LLC must maintain a legal presence there. Nearly all states require that the LLC maintain:

  1. A registered agent to receive service of process
  2. A registered office—the registered office could be an address located within or outside the state of formation, it could even be in a foreign country.

To form an LLC, you must file the articles of organization with the state’s secretary of state. This process is similar to filing certificates of limited partnership or articles of incorporation. The articles of organization you file will only need to contain general information about the LLC, such as its name, principal office, registered agent, business purpose, and duration.

Each state has its own fee structure for this filing process. Most states will also impose an annual registration or renewal fee.

In most cases, once your articles of organization are accepted by the state, the LLC exists as a legal business entity. Its official business lifespan  typically begin at the date of formation.

It’s also a good idea for LLCs to draft an operating agreement between its members even though most states don’t require it. Like General and Limited partnership agreements and corporate by-laws, an LLC operating agreement is the basic contract regarding managerial and financial rights and duties within the business hierarchy. Generally, your operating agreement should address issues such as:

  • Capitalization of the LLC
  • Sharing of profits and losses among the members
  • Members’ right to distributions
  • Members’ access to records
  • Management of the LLC
  • Admission and withdrawal of members
  • Amending of the operating agreement
  • Duties and authority of managers
  • Rights of members

Note: If an operating agreement goes contrary with federal or state law, the state or the federal law will prevail. LLCs may want to insert a severability provision to ensure that in the event that part of the operating agreement is invalidated , other aspect that are not contrary to the law may still remain in effect.

It is crucial that any LLC plan for the withdrawal and retirement of its members from the start. Most state statutes disclose that members may withdraw at any time unless the operating agreement expressly states otherwise. However, it’s common for state law to require a member to give written notice anywhere from 30 days to 6 months prior to withdrawing from the LLC.

Some state statutes also permit LLCs to recover damages from a member whose withdrawal violated the operating agreement. In such cases, the LLC is allowed to withhold damages from the amounts distributable to the withdrawing member. That makes it all the more important that the withdrawal process is made clear in the operating agreement at the formation of the LLC, to avoid later conflict or controversy.

In the case of single-member LLCs, an operating agreement is still a good idea. Here’s why:

  1. A written agreement supports the fact that an LLC is genuinely a apart from its owner.
  2. If the owner dies or transfers all or part of his or her interest in the LLC to multiple heirs, this can convert the LLC to a multi-member LLC. In that case, an operating agreement can help prevent conflict or controversy.
  3. An operating agreement may also let the LLC form relationships with third parties. For example, an operating agreement can clearly state that the member or an appointed manager of the LLC is authorized to carry out transactions with third parties.
  4. Creditors will be interested in seeing an operating agreement that includes a list of property contributed to the LLC.

Once you’ve drawn up an operating agreement and filed articles of organization with the state’s secretary of state, you’re ready to put your LLC to work. Congratulations!

Rights & Duties of LLCs

The rights and duties of an LLC can vary from business to business and state to state. However, there are some standard guidelines. Here are some useful tips:

1. Taxes:

An LLC can choose to be taxed as:

…In order to be taxed as a disregarded entity, the LLC must be owned by a single member or a married couples in community property states [See Rev. Proc. 2002-69, 2002-2 C.B. 831].

2. Voting and  Management:

By default, financial and voting rights are typically allotted proportionally to the member’s contribution. For example, if Dick invests $70,000 and Jane invests $30,000, Dick will have 70% control and Jane will have 30%. In some states, and in the absence of an operating agreement, the control is divided equally regardless of contributions. In that case, Dick and Jane will each have 50% control.

In a member-managed LLC, members are vested with management authority. In a LLC, management authority is delegated to a specific group of managers who may or may not be members. These managers are typically appointed by the members and have fiduciary duties similar to officers of a corporation.

LLC managers typically have the right to take legal action on behalf of the LLC. If a manager refuses or otherwise fails to take legal action when required, non-managing members can do so in his place.



3. Interest:

Interest in an LLC is considered Intangible personal property. Interest can include having rights to share in the profits and receive distributions or return of capital in accordance with the operating agreement.

The most common default for an operating agreement requires unanimous consent among members in order to transfer or alter:

  • Membership
  • Management
  • Rights to inspect the books or records
  • Rights to compel dissolution

Usually, members may assign economic interests without the need for approval from other members. In some states, the assignor retains rights of membership except for the financial rights that they transferred—though if the assignor transfers the entirety of their financial interests, their membership usually ceases.

4. Liabilities:

The members of LLCs personal liability for the obligations of the entity is only limited to the extent of their investment in the LLC . Potential personal liability is generally limited to those acts that result from negligent, wrongful acts or misconduct of a member in furtherance of the LLCs business.

In plain language , if a member of an LLC is personally engaged in fraudulent, tortious act, or criminal conduct or supervised or permitted the commission of these acts , the LLC member may be personally held liable for losses and injuries that resulted from such conduct.

Members MAY also be liable for:

  • Any written promise to contribute cash & property or to perform services
  • Wrongful distributions
  • Environmental torts of the entity
  • State taxes

Limited liability protections will no longer apply if the LLC entity is used to:

  • Defeat public interest
  • Commit fraud
  • Circumvent the law, be it federal or state
  • Shelter tax abusive schemes and evasion

The entity may be disregarded to prosecute the individual(s) committing misconduct. This is known as “piercing the corporate veil.”

“Piercing the corporate veil” refers to a situation in which courts put aside limited liability and hold a corporation’s shareholders or directors personally liable for the corporation’s actions or debts.

This might happen due to:

  • Under-capitalization
  • Not complying with LLC formalities
  • Not informing a third party that it is dealing with an LLC
  • Not establishing sufficient separation between members and the LLC entity

Most state statutes set guidelines for the records that an LLC must keep at its principal or registered office. This usually includes:

  • The name and last known address of each current member
  • Copies of the articles of organization with all amendments
  • All operating agreements
  • Copies of written promises by members to make capital contributions
  • Tax returns & financial statements for the past 3 years

How to Dissolve an LLC

All good things must come to an end, maybe even your LLC. For one thing, LLCs don’t usually have a perpetual lifespan

LLCs can be dissolved when:

  • All members provide written agreement to dissolve the LLC
  • A member withdraws, dies, is expelled, or declares bankruptcy (unless the operating agreement allows for the other members to continue)
  • A merger takes place, merger sometimes causes the dissolution of the old LLC and into the surviving LLC – New LLC
  • Duration is imposed by statute: Many states allow a perpetual duration , however , District of Columbia , and some other 11 states require have a requirement for duration to be specified

Upon dissolution, the managing members have the responsibility to wind up the LLC. This may include disposing of assets, discharging liabilities, prosecuting or defending of suits, and the closing of any transactions. It might also mean selling the business.

Whatever is required, it’s the responsibility of the members or manager(s) to make sure it gets done.

Need more information—or a little help—from a professional CPA?

LLCs are a very popular choice for a business structure, but that doesn’t make them simple. If you’d like some more information about:

  • How LLCs operate,
  • What they can and cannot do
  • How to take the most advantage of the benefits they offer

…feel free to get in touch with me. I’ll be happy to answer your questions.

And if you’d like some professional help in actually getting an LLC started, keeping proper books and records, making the right tax election, and filing annual tax returns—I can do that, too.

I’ll help you make the right financial decisions and lay the plans that will guide your business where you need it to go.

So just contact me, and we can get started. Let’s talk!

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