Estate Planning Blog

Thursday, September 22, 2016

LLC's in a Nutshell (by Kyle A. Krasa)

Limited Liability Companies, or “LLC’s,” are popular legal structures for maintaining investment assets or operating a business. Although they involve additional administration and specific formalities, they can also provide many benefits.   

Establishing an LLC:

One of the first considerations in establishing an LLC is choosing the right jurisdiction.  LLC’s may be formed in any of the 50 states regardless of where the owners, or “members,” reside or where the LLC is to conduct business.  The home state of the members might not necessarily be the optimum jurisdiction for forming an LLC.  Rules related to the degree of asset protection, taxation, and obligations members of LLC’s owe each other should be carefully contemplated when choosing the appropriate jurisdiction.  If a jurisdiction other than the location of the business is chosen, the LLC will have to register in each state in which it conducts business.

Another key consideration is how the LLC should be structured.  LLC’s may be structured as “single-member LLC’s,” where one person (or a married couple in a community property state) owns the LLC, or a “multi-member LLC” where multiple parties own the LLC.  By default, single-member LLC’s are treated as disregarded entities for income tax purposes, meaning that taxation falls upon the individual owner, while multi-member LLC’s are treated as partnerships for income tax purposes and a separate partnership tax return must be filed on behalf of the LLC each year.  However, both single-member and multi-member LLC’s may elect to be treated as corporations for income tax purposes.  

Naming the LLC is another important step.  Most jurisdictions provide searchable online databases to make a preliminary check on name availability.  If an LLC is to be formed in one state while it conducts business in another state, further investigation as to the name availability in both states should be performed.

After filing the application documents with the appropriate government agency in the state of establishment, it is often prudent to draft a detailed operating agreement that governs how the internal workings of the LLC should be conducted.  In addition, minutes of the initial meetings of the members should be executed, membership certificates to the owners should be issued, and assets should be transferred into the LLC.  

Pros of Establishing an LLC:

One benefit of establishing an LLC is to provide centralized management when there are multiple owners.  For example, if four siblings inherit rental properties, they might wish to appoint one manager to act on behalf of the rental properties to collect rent, authorize repairs, pay bills, and distribute the net income to the owners.  

Another benefit of forming an LLC is asset protection.  If properly established and administered, LLC’s in all 50 states will provide a degree of asset protection against “inside creditors,” that is creditors who have a claim against the business as a whole rather than against the individual members.  For example, if an LLC owns a rental property and a person is injured on the property, the plaintiff is limited to the assets of the LLC and is barred from pursuing a claim against assets of the individual LLC members.

In a limited number of jurisdictions, known as “charging order only” states, LLC’s can also provide a degree of asset protection against “outside creditors,” that is creditors who have a claim against the member personally rather than against the LLC as a whole.  For example, if a member of an LLC is liable for a personal act that is unrelated to the LLC such as a car accident or professional malpractice, LLC’s can prevent the plaintiff from pursuing a claim against the assets of the LLC or the member’s ownership interest in the LLC.      

LLC’s can also be useful as an estate tax reduction strategy.  Partial interests of LLC’s can be gifted to family members or friends over time in a manner that allows significant estate reduction that could potentially reduce the estate tax liability by hundreds of thousands of dollars or more.  

Cons of Establishing an LLC:

There are drawbacks to establishing and maintaining and LLC as well.  Although there are online, “do-it-yourself” companies that advertise they can establish an LLC for a nominal fee, such companies are not able to give comprehensive counsel on the many considerations mentioned above.  Often the better route is to consult both an attorney and a CPA when establishing an LLC which will result in professional fees.

Maintaining an LLC can also be expensive.  Many states require a “minimum franchise tax” to be paid every year for the privilege of owning an LLC.  Additional reporting requirements, tax filings, and formal administration procedures can also add to the expense and complication of running an LLC.  

Finally, for LLC’s that hold real property in California with a low property tax base, LLC’s are not eligible for the application of the parent/child exclusion for Prop. 13 tax purposes.  If an individual owns real property in an LLC at the time of his/her death, the individual’s children might be subject to a dramatic property tax reassessment that would not be applicable if the asset were held in the owner’s individual name or through a trust.  If the Prop. 13 assessed value is significantly lower than the fair market value, one will have to think carefully about whether the benefits of establishing an LLC are worth the potential property tax reassessment.

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Disclaimer: This article is for general information only.  Reading this article does not establish an attorney-client relationship.  Before taking action on any of the information presented in this article, you should consult a qualified attorney who is licensed to practice law in your community.

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