Basics About Properly Managing Your LLC
Limited liability companies have become very popular because of their flexibility with respect to internal organization and favorable tax treatment by the IRS. Below are a few basics to keep in mind as you operate a business using the limited liability company form of business entity.
It is very important that you keep in mind that your LLC is a business entity separate from yourself and any other potential members. If an LLC is operated as the alter ego of its members, creditors of the LLC may be able to recover for any claims against the LLC from the members, thus eliminating the advantage of limited liability.
In order to function as a separate entity, an LLC needs sufficient assets to operate its business. When your LLC is organized, you should contribute enough cash and other assets to provide the LLC with a reasonable chance of being successful. Ownership of the cash and assets must be transferred to the LLC—the LLC should not be operated primarily on money borrowed or assets rented from members.
If your LLC is funded sufficiently when organized, you need not contribute additional assets. But the adequacy of the LLC’s assets should not be jeopardized by distributions made to members. As a general rule, no distributions should be made to members until your LLC has accumulated sufficient profits to fund the distributions. State law prohibits an LLC from making any distribution that would cause its liabilities to exceed its assets or would prevent it from paying its obligations as they become due in the ordinary course of business. These insolvency restrictions are designed to protect an LLC’s creditors, and creditors can force members to return distributions that violate these restrictions to the LLC so that they are available for the payment of claims. The insolvency restrictions also apply to distributions that are required under the terms of the operating agreement.
As a separate entity, your LLC needs to have its own assets. The LLC must have a separate bank account and title to its other assets should be in the LLC’s name. Under no circumstances should the personal funds, assets, or accounts of members be mixed with those of the LLC. Similarly, LLC funds should never be used to pay personal expenses of members, to make personal investments for members, or for any other purposes not related to the LLC’s business.
The LLC’s cash or other assets can be transferred to members only in limited circumstances. While your LLC is actively engaged in business, transfers should only be made to members in three situations: (a) to make distributions permitted under the terms of the operating agreement and state law insolvency restrictions; (b) to reimburse members for reasonable expenses incurred on behalf of the LLC; and (c) to pay reasonable compensation for services performed by members for the LLC, the amount of which has been agreed upon in advance. You should note that reimbursement of unreasonable expenses and payment of unreasonable compensation may be treated as a distribution subject to the insolvency restrictions.
Members can lease property or loan money to the LLC, but appropriate arrangements should be made and documented. For example, if a member rents an office, production facility, or warehouse to the LLC, there should be a written lease, and the terms should be fair to the LLC. It is a good idea to document loans from members to the LLC with promissory notes and to provide for a reasonable rate of interest that is actually paid.
An LLC must be operated as an entity that is separate from its members. The business of your LLC should be conducted in the name of the LLC, and the LLC’s name should be used on all agreements, contracts, leases, orders, and other arrangements entered into by the LLC. This name should also be used on all products, signs, advertisements, correspondence, business cards, telephone directory listings, and similar items.
The LLC will need to obtain and carry its own insurance. In addition, you should maintain a relationship with an accountant to ensure that the financial records of the LLC remain in order.
An LLC can only act through its members. And when you act for your LLC, remember that you are an agent of the LLC and not just an individual operating for your own personal benefit. For example, a member should sign all documents on behalf of the LLC as follows: “[name of LLC] by [name of member], Member.” This makes it clear that you are signing in a representative capacity and are not accepting personal responsibility for the performance of the obligations created by the document.
LLCs exist under state law. If your LLC was created by filing a certificate of formation with the New York State Department of State, the filing will remain effective only if the LLC files its biennial report and pays any fees or taxes due. Failing to file required statements or to pay fees or taxes can lead to administrative dissolution of an LLC, resulting in the members’ loss of the protections afforded by limited liability.
An LLC may be taxed as a sole proprietorship (or disregarded entity), partnership, or as a corporation. You should consult with your accountant about the specific advantages and disadvantages of being taxed in one of those ways. As a general matter, sole proprietors pay taxes through personal income tax filings. Partnerships file informational returns, but pay no taxes, while each partner reports their share of profits and losses on their personal tax returns using a schedule K-1. Corporations must submit their own tax returns in addition to the tax return submitted by individual shareholders.
The default is to be taxed as a sole proprietorship if the LLC has only one member or as a partnership if the LLC has more than one member. You should maintain a regular dialogue with your accountant regarding your entity’s tax status.
Your LLC’s operating agreement provides a roadmap for conducting its operations in a manner that preserves the benefits of this form of doing business. You should refer to the operating agreement periodically to be certain that your LLC’s operations are being conducted properly.
The operating agreement serves four basic functions:
- to provide a record of the organization of the LLC;
- to provide the members (and managers if the LLC has managers) with a roadmap for LLC operations;
- to restrict the transfer of members’ interests and provide for smooth transitions through events like death, disability, or bankruptcy of a member; and
- to modify the statutory default rules that might otherwise apply to the LLC.
It is important that you remain apprised of the content of your operating agreement and of provisions that should be changed as your business grows and you take on employees or additional members. The operating agreement may be amended from time to time, and will require revision if you accept new members.
By statute, your LLC is required to keep on hand at all times certain records. You should consult your operating agreement and the New York Limited Liability Law for a specific list. As of this writing, the records required are:
(1) if the limited liability company is managed by a manager or managers, a current list of the full name set forth in alphabetical order and last known mailing address of each such manager;
(2) a current list of the full name set forth in alphabetical order and last known mailing address of each member together with the contribution and the share of profits and losses of each member or information from which such share can be readily derived;
(3) a copy of the articles of organization and all amendments thereto or restatements thereof, together with executed copies of any powers of attorney pursuant to which any certificate or amendment has been executed;
(4) a copy of the operating agreement, any amendments thereto and any amended and restated operating agreement; and
(5) a copy of the limited liability company’s federal, state and local income tax or information returns and reports, if any, for the three most recent fiscal years.
On February 25, 2015, state legislation passed making the ten LLC members with the largest ownership interests in the LLC personally liable, jointly and severally, for all debts, wages or salaries due and owing to any of the LLC’s laborers, servants or employees, for services performed by them for the LLC. You can see more about this here.
This blog post is not intended to consist of legal advice and you should always consult with a lawyer before acting on anything you find on the Internet. If you have questions or comments about this post, about the topic, or if you need legal assistance, you should feel free to give us a call or send us an email. Let us know how a New York City LLC lawyer can assist you.