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What is an LLC?
A Limited Liability Company (LLC) is a business entity that is formed with the filing of a Certificate of Formation. An LLC provides limited liability to its members and taxation like a partnership, preventing double taxation.
People from all over the United States and the world flock to Delaware for the protection and flexibility of the Delaware LLC. For each of the past five years, the United States Chamber of Commerce has ranked the Delaware Court system number one of all 50 states in terms of fairness and competence. Choose the Delaware LLC for your business and you will enjoy the business-friendly rules that are more favorable than those available in any other state or foreign country.
Why Form an LLC?
A common reason a business might choose to become an LLC is because of an LLC's tax classification flexibility - A new LLC incurring losses or owning capital appreciation assets like real estate operates as a sole proprietorship or partnership so that losses and capital gains pass through to the owners.
A service or profitable LLC might elect to operate as an S-Corporation to cut down on self-employment taxes. An LLC desiring to accumulate working capital or build equity may elect to be taxed as a C-Corporation.
Why is the LLC so Popular?
An LLC allows for the flexibility of a sole proprietorship or partnership structure while possessing limited liability (such as that granted to corporations). An advantage of an LLC, as opposed to a limited partnership, is that the LLC does not require a general partner. A General Partner is a managing partner in an LP that is exposed to personal liability. Two examples of the LLC’s flexibility compared to corporations are:
the lack of requirement for annual meetings of shareholders (LLCs have "members") and no requirement for Bylaws. Most LLCs will, however, choose to adopt a Limited Liability Company Operating Agreement, and this agreement is generally more complex than a corporation's bylaws.
One feature of the LLC, mentioned above, is that an LLC can elect how it should be treated for federal and state income tax purposes. An LLC with one owner is treated as a sole proprietorship by default (when an LLC has a single owner - either an individual or an entity - it is disregarded for federal taxes), but this one-owner LLC can also elect to be treated as a C-Corporation or as an S-Corporation.
Additionally, an LLC with more than one owner is treated as a partnership by default, but a multi-owner LLC can also elect to be treated as a C-Corporation or as an S-Corporation. To elect a C-Corporation treatment, an LLC files a Form 8832 with the IRS. To elect an S-Corporation treatment, an LLC files a Form 2553 with the IRS.
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LLCs vs. Corporations
Deciding to form an LLC cannot be a mistake. Your LLC can later be converted into a corporation and a corporation may be converted into an LLC at any time. From a tax angle, an LLC can elect to be taxed as a C-Corporation or an S-Corporation. In general an LLC is the preferred entity of choice. It is more flexible for U.S. and foreign owners, has fewer formalities than a corporation and just as much liability protection. Many commentators agree that the Delaware LLC has much more asset protection than a corporation.
Cases in which a Delaware LLC should be selected over a Delaware Corporation:
- Real estate or other passive investments will be purchased.
- Any owner will be a non-resident alien.
- Individuals are concerned about filing their names in state records.
- Tax benefits wish to be distributed disproportionately to ownership.
- The LLC will be used as a subsidiary or for a special purpose.
Cases in which a Delaware Corporation should be selected over a Delaware LLC:
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- Companies intend to be listed on a stock exchange.
- Companies seek investors who want stock, not “interests” or “units.”
- Companies would like a corporate ending, such as "Inc."
- Non-Profit corporations.
Advantages and Disadvantages of Forming an LLC
Advantages of Forming an LLC
- No required annual general meeting for shareholders.
- Much less administrative paperwork is involved.
- Default pass-through taxation (no double taxation).
- Owners of the LLC are protected from liability for acts and debts of the LLC.
- Profits are taxed personally at the member level, but not at the LLC level.
- Can be set up with just one person as the owner and manager.
- Check-the-box taxation: An LLC is taxed as a sole proprietorship or partnership unless it elects S-Corporation or C-Corporation tax status.
- Asset Protection: A Delaware LLC provides “Charging Order” as the exclusive remedy to personal creditors of a Member, giving a personal creditor an economic interest in the LLC without a control interest. This protects the other Members of the LLC from your creditors and visa-versa. Some other states allow a creditor to control or even liquidate an LLC to pay-off an outstanding judgment!
- Family Planning: Gifts of LLC Units can be discounted and be non-voting while the family leader retains voting control and management rights.
Disadvantages of Forming an LLC
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- It may be more difficult to raise capital for an LLC since Venture Capitalists and old-fashioned investors may be more comfortable investing funds in corporations which have the potential of an initial public offering (IPO).
Common Uses of an LLC
Common uses of the Delaware LLC include:
(Click on one of the following topics to learn more)
Special Types of LLCs
The Delaware Series LLC: Many LLCs in One
The Delaware Series LLC is a unique Delaware LLC with unlimited asset segregation potential. Within the Delaware LLC Act, a special provision provides for one entity to act like many entities. Under one Series LLC you can set up numerous "series," with each owning separate assets. According to the statute, 6 Del. C. Section 18-215,
"The debts, liabilities, obligations and expenses incurred, contracted for or otherwise existing with respect to a particular series shall be enforceable against the assets of such series only, and not against the assets of the company generally or any other series thereof," [as long as separate books and records are kept for each series.]
The Delaware Series LLC is the most cutting-edge entity on the market. The Series LLC is a product of the Delaware legislature, the most highly regarded body for drafting corporate laws. When forming a company, business promoters have a choice of jurisdictions (“forum shopping”). Many knowledgeable entrepreneurs and real estate investors have chosen Delaware because of its low costs, business-friendly courts, innovative laws and dependable liability protection.
Unlike a conventional LLC in any other state, a Delaware Series LLC has the advantage of having multiple, even unlimited, liability baskets (or "series") under one organizational umbrella (the "company"). The Series LLC is tantamount to a number of separately filed LLCs. The protection is often called “ring fencing.” The protection afforded by this one entity, coupled with unlimited liability and asset segregation potential, makes the series LLC a very powerful and cost effective asset protection tool.
Usually the Series LLC is set up with a much longer and customized 50+ page Operating Agreement for the Series LLC. We will prepare a 50-page Operating Agreement for the Series LLC, ready for signature. We will send you both a hard copy and emailed version (should you wish to edit the agreement or add additional series).
Separate Series Agreements
In addition to the Operating Agreement for the Company, each series under the umbrella typically has its own Separate Series Agreement, which can be agreed upon subsequent to the Company’s Operating Agreement. Each basket or series holds assets in its own name, (e.g., ABC Capital LLC, Series 1). Separate Series may be terminated at a different time than the Company by using a Separate Series Agreement. Some owners obtain separate EIN numbers for each series and open separate bank accounts for each series. The Certificate of Formation does not need to be amended as series are added.
The Series LLC is taxed like a traditional LLC - either as a sole proprietorship for a one-member LLC or as a partnership for a multiple-member LLC. There is one tax payer ID number required for the entity, although some accountants request separate EINs for each cell. (Note: The IRS recently issued a Private Letter Ruling regarding a Delaware Series LLC. It permits series within a Series LLC to request separate tax ID numbers and file separate returns and even make separate tax elections. PLR 200803004.)
Multiple Parcels of Real Estate
For Real Estate investors with multiple properties, the Series LLC isolates each of the properties in separate cells. In states such as California, Texas and New York that require high fees to maintain separate companies, the Series LLC may be registered as a single foreign entity, saving on annual filing fees. The Delaware Series LLC needs to qualify only once as a foreign company doing business in the state where the property is located. We can order a Delaware Certificate of Good Standing for an additional $99. This may be required by the Secretary of State in your home state.
The Delaware LLC Act empowers one or more members to build “fire-walls” between assets and liabilities within a single entity. One principle is to prevent a creditor of one cell (also known as a "series", "basket", "container" or "cell") within the LLC from collecting against other unrelated cells within the same LLC.
Adding Additional Series
The Series LLC members may add additional series within the LLC by simply signing a three page addendum to the Operating Agreement. While we set-up two series as part of the Incnow Series LLC package, additional series may be added at any time. This simple procedure, along with the requirement of maintaining separate books and records, makes the Series LLC an attractive alternative for the sophisticated investor or ambitious entrepreneur.
Multiple Product or Service Lines
Entrepreneurs and small businesses with different product or service lines can similarly incubate new products or services in separate cells. Properties and businesses may later be "spun-off" into separately filed LLC's. Cells may be terminated at any time with the consent of the members.
“Hot” and “Cold” Assets
Sometimes the Series LLC may be used to "group" businesses or properties. An individual may therefore have two or more separate Series LLC to protect "hot" (high-liability) assets, such as active businesses, from "cold" (low-liability) high-value assets such as real estate. Hot and cold assets should not be kept within the same Series LLC even if they are designated to separate cells.
Registered Agent and Annual Report
In Delaware the Series LLC only requires one registered agent and one annual report fee of $250 per year regardless of the number of series within a Series LLC.
Is a Series LLC Right for You?
The series LLC is mainly for people whose only alternative is a single traditional LLC. I always advise people to form separate entities as an alternative to a series and not to over-fund the series with more assets than they could tolerate all being subject to one judgment if a large judgment is rendered. Even with the disclaimers and warnings, the series LLC simply suits some people better. The Series LLC is not for everyone. More predictable asset segregation comes from multiple entity filings. At this time the Series LLC is best suited for those who have decided that the costs to file and maintain multiple entities are not justifiable.
Other Uses of the Series LLC
The Delaware Series LLC has been used in a variety of contexts outside series states, such as:
- Mutual funds avoiding the need to file more than one application with the SEC for separate classes of funds.
- Owning containers to be shipped overseas,
- An incubator for entrepreneurs with many business ideas (which may later be spun-off into separate LLCs if ideas start to take flight),
- To own trailer park lots,
- To franchise businesses,
- Incentive compensation for employees,
- To own intellectual property,
- To own a cluster of real estate investments (from developers to owners of worthless properties in New Orleans),
- For family gifting.
The Series LLC in Other States
Series LLC legislation has been adopted by five other states, although the drafters of the Model LLC Act have decided not to include it to date because of uncertainty as to how this will be treated by courts in non-series states.
In Delaware and the four other states that have Series LLC statutes, these internal liability shields will most likely be respected. In non-series states the internal protection is more speculative. An out-of-state judge may decide not to import Delaware law for matters that are outside the scope of the “internal affairs doctrine.”
In any case, the odds of being "the first patient on the table" will likely also give a series LLC owner the opportunity to transfer property out of a series if there is a wave of negative case law from non-series states. The trend at the moment is in favor of the series LLC. A few states have adopted series LLC acts recently. Many view the California Franchise Tax Board (“FTB”) ruling as a positive development (requiring a franchise tax from each series within an LLC as though it were a separate LLC). While the FTB ruling in California may impose additional fees, the ruling also recognizes the series as though they were separate LLCs (at least for tax purposes). This would make it easier for a defendant to make the argument that separate series should also be separate for liability reasons; otherwise, California is taxing a privilege it is not affording.
Additional Notes about the Delaware Series LLC
The legislation authorizing the Delaware Series LLC is found within the Delaware LLC Act at 6 Del. C. §18-215. It requires an LLC to provide notice in its Certificate of Formation that the members intend to establish series of assets and operations within the LLC.
“Provided separate books and records are kept for the assets, the LLC liabilities of one series cannot go against the assets of another series within the same LLC.” (emphasis added).
It is also a good idea if using a series to carefully word contracts entered into by the series. Delaware law may be chosen to govern contracts if selected by the parties. The remedies available to a party (future judgment creditor) can also be restricted in part if expressly stated by the parties.
A party to a contract (not the Operating Agreement, but a contract with a third party) has the opportunity to limit the rights and remedies available to the other party at the outset. Using a Delaware Series LLC is one way to limit the other party's rights. For example, the contract could state:
"ABC Capital LLC, 5 Main Street Series, a Delaware Series LLC neither ABC Capital LLC as a whole, nor any other series therein, aside from 5 Main Street Series, are a party to this agreement. Under any and all circumstances, the other party's remedy, including equitable and money damages, for any and all breaches of this agreement shall not apply to the ABC Capital LLC nor any other series therein and shall not exceed the value of assets held by 5 Main Street Series alone. The other party knowingly and expressly waives any right to collect a future judgment on, or put a lien against, any assets other than those held by 5 Main Street Series alone." (It may also be prudent to limit the creditors to a charging order against the series alone, but that may be over-reaching).
The governing law and/or forum can also be stipulated:
"This agreement is to be governed by Delaware law in Delaware courts to the maximum extent allowed.”
Incnow Series LLC Package
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Our price for the Series LLC is $598, which includes the Operating Agreement.
[Click Here to order a Series LLC]
This $598 package is usually sent out within 5 business days and includes:
- Delaware filing fees and Certificate of Formation
- First year's Registered Agent service
- Priority mail postage
- The Series Operating Agreement that contains:
- A 37-page Company Agreement to establish and manage the umbrella organization
- Two separate Series Agreements (to establish the baskets underneath the umbrella in which all assets and activities take place; more series may be added anytime at the member's discretion without additional filings by drafting and signing an additional separate series agreement following our easy-to-use template)
- Separate Series Termination Agreement (for when you want to eliminate a series)
- Table of Contents
- Instructional cover letter on how to title contracts, title real estate, open bank accounts and obtain an EIN number
- The above signature-ready agreements in paper and electronic Microsoft Word format
The International LLC
Frequently Asked Questions:
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Q. Why use a Delaware LLC for overseas business or property?
A. Most International clients choose a Delaware LLC for:
- Tax advantages
- Low cost
Q. If my Delaware LLC does business in the United States, must it pay tax in the United States?
A. Yes. Any income substantially connected to the United States must be reported to the IRS.
Q. Must a Delaware LLC have a bank account and/or office in Delaware?
Q. Can a Delaware LLC operate anywhere in the world?
A. A Delaware LLC can qualify to do business in foreign countries. Since many nations want to encourage economic ties with the United States, those nations typically permit a Delaware LLC to own property or run businesses internationally. Typically, foreign countries require the LLC to apply to do business. We can supply the LLC Good Standing Certificate or Apostille for the application.
Q. Why form a Delaware LLC and not a Delaware Corporation?
A. The Delaware LLC default tax status is: partnership (a pass-through tax status). The default tax status for a C-Corporation is "double taxation." Only U.S. citizens and permanent resident aliens are permitted to make the S-Corporation election to avoid "double taxation". Thus, choosing a Delaware LLC may reduce the U.S. tax burden.
Q. What other services do you offer to international clients?
A. Non-resident aliens may be interested in the following Incnow International Services:
- 5-Minute Complete Delaware LLC formation services ($298 including filing fees and agent service)
- Delaware Registered Agent service ($90/year, first year is free with order)
- Domestication of non-Unites States companies to Delaware (e.g. Channel Islands Corporation becomes a Delaware LLC). The laws of the formation's nation must also permit such re-domestication. Our fee does not include review or compliance with foreign law. ($837 includes agent fee, processing, Certificate of Formation, Certificate of Domestication, good standing, Certified Copy, International Fed Ex)
- DHL, or International Fed Ex package delivery ($129)
- Bank account referral & mail forwarding referral available upon request (free referrals with service)
- Apostille of good standing and/or certified copy of certificate of formation for Hague Convention signatory nations ($159), or legalization of good standing and/or certified copy of the certificate of formation with United States Department of State and foreign consulate in the United States for non-Hague Convention nations (fees and time vary, $550+)
Sample LLC Operating Agreement
ARTICLE I. FORMATION AND PURPOSE
- 1.1 Governing Law and Government Filings
- 1.2 Name
- 1.3 Purpose of the Company
- 1.4 Registered Office; Registered Agent
- 1.5 Principal Place of Business
- 1.6 Expenses of Formation
ARTICLE II. TERM
ARTICLE III. CAPITAL CONTRIBUTIONS AND COMPANY INTERESTS
- 3.1 Company Capital
- 3.2 Initial Capital Contribution
- 3.3 Payment of Contributions
- 3.4 Company Interest
- 3.5 Percentage of Company Voting Interests
- 3.6 Form of Contributions
- 3.7 Additional Capital Contributions
- 3.8 Withdrawal of Capital Contributions
- 3.9 Use of Contributions
- 3.10 Ownership of Property
- 3.11 No Right of Property
- 3.12 Composition of Capital Accounts
- (a) Contributions, Income and Gains
- 3.13 Transferee's Capital Account
- 3.14 Compliance with Applicable Federal Tax Laws
ARTICLE IV. ALLOCATIONS AND DISTRIBUTIONS
- 4.1 Allocation of Company Items
- 4.2 Priority among Members
- 4.3 Reallocation on Transfer
- 4.4 Distribution of Net Cash
- 4.5 Draws
ARTICLE V. COMPETITION
ARTICLE VI. TAX, FINANCIAL AND ACCOUNTING MATTERS
- 6.1 Fiscal Year and Accounting Method
- 6.2 Annual Tax Return and Financial Statements
- 6.3 Tax and Accounting Matters
- 6.4 Books and Records
- 6.5 Bank Account
ARTICLE VII. MEMBERS
- 7.1 Management Authority of Members and Officers
- (a) President
- (b) Secretary
- (c) Treasurer
- 7.2 Duties of Loyalty and Care of Members
- 7.3 Powers of the Members
- 7.4 Compensation for Members
- 7.5 Indemnification of Members
- 7.6 Personal Liability of Members
ARTICLE VIII. ADMISSION, REMOVAL AND RESIGNATION OF MEMBERS
- 8.1 Initial Members
- 8.2 Additional Members
- 8.3 Successor Members
- 8.4 Preconditions to Admission
- 8.5 Assignee of a Member
- 8.6 Resignation of Members
- 8.7 Payments to Wrongfully Resigning Member
- 8.8 Removal of a Member
ARTICLE IX. TRANSFER OF COMPANY INTERESTS
- 9.1 Transfers Restricted
- 9.2 "Transfer" Defined
- 9.3 Transfer Not an Event of Dissolution
- 9.4 Voluntary Transfer; Mandatory Offer to Company
- (a) Offer for Sale
- (b) Acceptance of Offer
- (c) Purchase Price and Payment Terms
- (d) Rights of First Refusal
- (e) Purchase of Entire Interest
- 9.5 Purchase Price
- (a) Capital Account Value
- (b) Adjustments to Capital Account
- (c) Valuation Date
- (d) Third Party Offer
- 9.6 Payment Terms and Conditions
- (a) Cash Payment
- (b) Promissory Note
- (c) Additional Provisions for Promissory Note
- (d) Security for Promissory Note
- (e) Third Party Offer
- 9.7 Involuntary Transfer; Option to Purchase by Company
- 9.8 Permitted Transfers
- 9.9 Percentage of Limitations or Transfers
- 9.10 Costs and Expenses of Transfer
ARTICLE X. DISSOLUTION
- 10.1 Waiver
- 10.2 Events Causing Dissolution
- 10.3 Winding Up
- 10.4 Final Accounting; Deficit Capital Accounts
- 10.5 Priority of Distributions
- 10.6 Payment of Claims
- 10.7 Distributions in Kind
ARTICLE XI. GENERAL PROVISIONS
- 11.1 Notices
- 11.2 Enforceability
- 11.3 Descriptive Headings
- 11.4 Governing Law
- 11.5 Binding Effect
- 11.6 Entire Agreement
- 11.7 Waiver of Breach
- 11.8 Authorship
- 11.9 Time of the Essence
- 11.10 Gender
- 11.11 Agreement in Counterparts
- 11.12 Arbitration
- 11.13 Tax Status
In Witness Whereof... Signatures
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(In the absence of an agreement to the contrary)
6 Del. C. 18-1101(a) - The rule that statutes in derogation of the common law are to be strictly construed shall have no application to this chapter.
6 Del. C. 18-1101(b) - It is the policy of this chapter to give the maximum effect to the principal of freedom of contract and to the enforceability of limited liability company agreements.
6 Del. C. 18-1101(c) - To the extent that, at law or in equity, a member or manager or other person has duties (including fiduciary duties) to a limited liability company or to another member or manager or to another person that is a party to or is otherwise bound by a limited liability company agreement, the member’s or manager’s or other person’s duties may be expanded or restricted or eliminated by provisions in the limited liability company agreement; provided that the limited liability company agreement may not eliminate the implied contractual covenant of good faith and fair dealing. A limited liability company agreement may not eliminated the implied contractual covenant of good faith and fair dealing regarding legal or equitable duties, nor may it (e) eliminate liability for any act or omission that constitutes a bad faith violation of the implied contractual covenant of good faith and fair dealing.
6 Del. C. 18-1101(d) - Unless otherwise provided in a limited liability company agreement, a member, manager or other person shall not be liable to a limited liability company or to another member or manager or to another person that is a party to or is otherwise bound by a limited liability company agreement for breach of fiduciary duty if they relied in good faith on the provisions of a limited liability company agreement.
6 Del. C. 18-1101(e) - A limited liability company agreement may provide for the limitation or elimination of any and all liabilities for breach of contract and breach of duties (including fiduciary duties) of a member, manager or other person to a limited liability company or to another member or manager or to another person that is a party to or is otherwise bound by a limited liability company agreement; provided that a limited liability company agreement may not limit or eliminate liability for any act or omission that constitutes a bad faith violation of the implied contractual covenant of good faith and fair dealing.
Member Fiduciary Duties: Delaware Case Law
Absent any contrary provisions in the operating agreement, courts will impose stringent duties of loyalty, good faith, and fair dealing on member-managers. See VGS, Inc. v. Castiel 781, A.2d. 696 (Del. 2001); Anest v. Audino, 332 Ill. App. 3d 468 (2002).
With regards to fiduciary duties and members competing with the LLC's interests/business, an Ohio court has found that operating agreements allowing members to compete against the LLC are enforceable even though it directly conflicts with the duty of loyalty under the common law for partnerships. McConnell et al. v. Hunt Sports Enterprises 725 N.E. 2d 1193 (Ohio 1999).
By contract in a limited liability company agreement, beneficiaries may insulate their fiduciaries from liability for any breach of the duty of care (including ones relating to disclosure). Metro Communication Corp. BVI v. Advanced Mobilecomm Technologies Inc., 2004 WL 1043728 Del. Ch., 2004.
In Walker v. Resource Development Company, Limited, L.L.C., the court found a breach of fiduciary duties by member-managers of an llc. Walker v. Resource Development Company, Limited, L.L.C. 791 A.2d 799, 27 Del. J. Corp. L. 463 (Del.Ch. 2000). Randolph T. Walker (“Walker”) was a former member of a limited liability company, Resource Development Company Limited, L.L.C. (the “REDECO”) sued the remaining members after they terminated him from the company and extinguished his share in the company. Id. at 804. The Chancery Court found that the unilateral removal of a member breached the operating agreement
as well as the Act and also found that Walker was entitled to a constructive trust on his 18% interested in REDECO. Id. at 818. This court states that “there is not support in the operating agreement of the LLC [of REDECO] or the law governing such entities, for the expropriation of a member’s equity interest.” Id. at 800.
Walker was hired as a “fundraiser” for REDECO due to his family connections with Former President George H.W. Bush (cousin) and high level executives in the foreign oil business. Walker at 801. When Walker was unable to obtain funding from the Appian Group, a potential backer, the remaining members of REDECO terminated Walker. Id. at 808-809. The remaining member sent a termination letter to Walker asserting breach of contract and directly stating that they “hereby terminate your ownership interest in the firm.” Id. at 808. The remaining members also sought alleged outstanding obligations owed by Walker to REDECO in the amount of $4,179.43. Id. at 808. The primary reason the court found for the termination was the inability to secure the investor and the court dismissed other possible factors such as potential conflict of interest and alcoholism on the part of Walker as reasoning for the termination. Id. at 815.
Member Fiduciary Duties: Non-Delaware Case Law
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Common law fiduciary duties, similar to the ones imposed on partnerships and closely-held corporations, are applicable to Indiana limited liability companies. Purcell v. Southern Hills Investments, LLC 847 N.E.2d 991 Ind.App., 2006. The LLC co-manager’s conduct amounted to willfulness or recklessness thereby making him liable for breach of fiduciary duty subjecting him to pay damages for using company funds to pay off a personal loan. Fiduciary must deal fairly, honestly, and openly with his corporation and fellow stockholders. G&N Aircraft, Inc. v. Boehm, 743 N.E.2d 227, 240 (Ind. 2001).
Wisconsin limited liability company law does not preclude members of a limited liability company with a material conflict of interest from voting their ownership interest with respect to a given matter; rather, it prohibits members with a material conflict of interest from acting in a manner that constitutes a willful failure to deal fairly with the LLC or its other members. Gottsacker v. Monnier, 697 N.W.2d 436 (Wis. 2005); W.S.A. 183.0402, 183.0404.
The Virginia Supreme Court has applied what is known as the “Closed Corporation” or “Corporate Formalities” rule to limited liability companies. This rule states that while formal action is generally required to establish a valid act by a limited liability company, when members of closely-held LLC conduct business in an informal manner and ignore statutory requirements or requirements set out in the Articles of Organization or Operating Agreement, their actions may nevertheless be binding on the company.
Virginia Gowin v. Granite Depot, LLC 634 S.E.2d 714 (Va. 2006). See Curley v. Dahlgren Chrysler-Plymouth Dodge, Inc., 245 VA. 429, 433-34, 429 S.E. 2d 221, 224 (1993); Brewer v. First National Bank of Danville, 202 Va. 807, 812-13, 120 S.E.2d 273, 278 (1961): Moore v. Aetna Cas. & Surety Co., 155 Va. 556, 568-70, 155 S.E. 707, 710-11 (1930).
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6 Del. C. 18-404(c) - Classes and Voting - Managers - A limited liability company agreement may grant to all or certain identified managers or a specified class or group of the managers the right to vote, separately or with all or any class or group of the managers or members, on any matter. Voting by members may be on a per capita, number, financial interest, class, group, or any other basis.
6 Del. C. 18-404(d)
- Classes and Voting – Managers - Unless otherwise provided in a limited liability company agreement, meetings of managers may be held by means of conference telephone or other communications equipment by means of which all persons participating in the meeting can hear each other, and participation in a meeting pursuant to this subsection shall constitute presence in person at the meeting. Unless otherwise provided in a limited liability company agreement, on any matter that is to be voted on, consented to or approved by managers, the managers may take such action without a meeting, without prior notice and without a vote if a consent or consents in writing,
setting forth the action so taken, shall be signed by the managers having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all managers entitled to vote thereon were present and voted. Unless otherwise provided in a limited liability company agreement, on any matter that is to be voted on by managers, the managers may vote in person or by proxy, and such proxy may be granted in writing, by means of electronic transmission or as otherwise permitted by applicable law. Unless otherwise provided in a limited liability company agreement, a consent transmitted by electronic transmission by a manager
or by a person or persons authorized to act for a manager shall be deemed to be written and signed for purposes of this subsection. For purposes of this subsection, the term "electronic transmission" means any form of communication not directly involving the physical transmission of paper that creates a record that may be retained, retrieved and reviewed by a recipient thereof and that may be directly reproduced in paper form by such a recipient through an automated process. (68 Del. Laws, c. 434, § 1; 71 Del. Laws, c. 77, § 27; 71 Del. Laws, c. 341, § 13; 72 Del. Laws, c. 389, § 22; 73 Del. Laws, c. 83, § 17; 75 Del. Laws, c. 317, § 34.)”
Most Common Uses of the LLC
To Hold Real Property*
* (Real property is land, and generally whatever is erected or growing upon the land. Also rights issuing out of, annexed to, and exercisable within or about land)
Personal Real Estate
The LLC may be used to hold personal assets, although some commentators suggest that the protection may be compromised because the entity has no cognizable business purpose. An asset protection trust is a better alternative to the LLC for certain liquid personal assets.
The Delaware Asset Protection Trust (“Delaware APT”) is an irrevocable trust that meets certain statutory requirements and provides a good deal of protection from a variety of future creditors (except for marital and child support obligations). Such Delaware APTs under the right circumstances are the preferred method for protecting personal assets, such as investment securities. The Delaware APT should be distinguished from the revocable trust used for estate planning purposes. The revocable trust is for flexible asset management and tax planning, not asset protection. The LLC may be used in conjunction with a Delaware APT. To establish a stronger situs to Delaware, assets may be titled in an LLC whose single member is the Delaware APT.
Mixing business purpose assets and personal use assets into a single entity exposes personal assets to the judgment creditors of the business. Ideally, individualized LLCs should be used for holding particular assets, most importantly when separating hot business assets from cold personal assets. Business purpose assets may include investment real estate, such as a beach house, residential rentals or commercial leaseholds. These real property titles may be in the name of an LLC. A Delaware LLC is the preferred liability shield entity for ease of management and restricting the rights of future creditors. Many out-of-state investors form LLCs in Delaware and qualify them in foreign jurisdictions to import Delaware protections though the full faith and credit clause of the United States Constitution.
Whenever feasible, it is important to use separate LLCs with each investment property. Investors should avoid “putting all their eggs in one basket.” The judgment liens from one LLC may not be enforced against the assets of another LLC. This usually insulates assets and prevents cross-liability.
The best practice to achieve asset segregation is to file separate LLCs. For those who elect to hold multiple assets in a single LLC, an equal or greater degree of asset segregation may be obtained by using a Delaware Series LLC, described later in this page. The Delaware Series LLC, in a nutshell, is an umbrella entity in which the members are permitted to designate classes of assets that are not subject to the judgments of other series within the same LLC.
Business Real Estate
The operations of an active business should be owned separately from the real estate upon which the business operates. The rationale behind using a split ownership model is illustrated by the example of a restaurant patron who suffers damages as a result of food poisoning. Should that patron win damages in a lawsuit not covered by insurance, he becomes a judgment creditor. Utilizing two “bifurcated” entities, the judgment creditor may only be entitled to a judgment lien against the operational business, not the real estate. To best protect the owner’s assets in this scenario, the operating entity should lease the real estate from a separate entity whose sole purpose is to own the real estate.
To add a gifting element, a business owner may consider having his or her children, even minor children, be non-voting members of the LLC with a majority of the ownership interest. Assuming the real estate is fully mortgaged, no present gift is realized by the children or recognized by the IRS since the debt equals the equity. The lease payments over time are used to make mortgage payments and, in turn, would be one method of building up equity, plus the property appreciation in value, in the children’s names without increasing the size of the parent’s estate.
In addition, the dual entity structure enables the owner to “bifurcate” the tax elections. It is more advantageous to run the operations of a restaurant as either a C-Corporation or an S-Corporation (or an LLC that elects to be taxed as a “C” or “S” Corporation). This is to avoid paying unnecessary self-employment taxes on income that may be able to take advantage of a fiscal year, S-dividend, or carry-over of losses and profits to income average.
Real estate should not be held in a C-corporation because any appreciation in value of the real estate would be taxed as ordinary income to a C-corporation, which must then be dividended out to stockholders and taxed again. The lease of the real estate is a passive investment, which may disqualify an S-election. Therefore, LLCs are always advised for holding real estate. An LLC, by default if none of the “check-the-box” elections are made, will be taxed as a partnership (if it has two or more members) or as a sole proprietorship (if it has one member).
Business real estate should therefore be held through an LLC to take advantage of “pass-through” taxation. Any appreciation in value for real estate held for more than one year would be subject only to the owner’s personal long-term capital gains rate, currently 15% (Code Sec. 731(b)). Additionally, for a single-member LLC, there is no separate tax return required for the entity. The income and expenses may be listed on the single-member’s Schedule C of his or her 1040 tax return.
Financing Through an LLC
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Frequently, real estate investors hold property in their own name because banks will either not finance property held in an LLC or will offer less favorable rates to LLC lenders.
When financed and titled in an individual’s name, banks almost never consent to re-title real estate into the name of an LLC without refinancing. It is not unusual for individual grantees to take title in their own name to obtain favorable rates and subsequently flip the properties into an LLC (provided the transaction in question is real estate transfer tax exempt, as it would be in Delaware).
What about the “due-on-sale” clause? Won’t a flip into an LLC trigger it? Yes, and you should be aware of the consequences. Frequently, banks reserve the right to call the loan if the due-on-sale clause is violated. Should the bank run a title search and discover that the property has been transferred, borrowers typically then have 30 days to refinance the property either back into their individual names or into the LLC names.
However, banks rarely run title searches unless the loan is in default. Provided the loan remains current, the banks do not exercise the due-on-sale clause since the mortgagee is unaware that the title has transferred.
Also, banks systematically require lenders to personally guarantee the loan, even if the property is held by an LLC. In other words, the bank is fully secured whether the property is in the lender’s individual name or the name of the LLC.
To Hold Tangible Personal Property or Intangible Assets
Titling Airplanes and Boats in LLCs
Boat owners title their vessels in the name of an LLC for similar reasons, since boats are “hotter” assets. Boats are more prone to accidents and the resulting liability than is relatively passive real estate. A vehicle operator should be aware that he is still liable for his own personal acts and omissions, especially if he is the captain in charge of the craft. Also, since Delaware does not have a sales tax, the purchaser of a boat may achieve savings by using an LLC even for a boat docked outside of Delaware (although other states have the reciprocal to the sales-tax, namely the use-tax). This practice has become less common as foreign states have become more vigilant in monitoring and collecting the use-tax by inspecting marinas.
Airplanes are also prone to obvious dangers. It is not wise to title a passenger aircraft in the owner’s personal name. Again, the purchaser of an aircraft can achieve significant savings on sales tax if the seller agrees not to collect the sales tax because the aircraft is to be held in a Delaware LLC.
Although both boats and aircraft may be chartered, aircraft owners should be especially careful when deciding whether to rent out their aircraft, depending on the type of license the owner has with the FAA. The FAA classifies leasing aircraft or providing flight for hire as a commercial aircraft differently than personal aircraft. The duty of care and liability for a common carrier is also much greater than that of a licensee/guest who has a free ride.
Corporations are less preferred for tangible personal property because of the tax inflexibility (no option for a corporation to be taxed as a partnership under section K). In addition, corporations require annual meetings, elections and the bureaucracy of Directors, stockholders and Officers. Corporations generally have more stringent protocol for selling assets held in a corporation.
Intellectual Property (Copyrights, Patents and Trademarks)
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Some states charge an intangible personal property tax, but Delaware does not. Often, large firms with valuable intellectual property will hold those assets in Delaware entities. Those big firms typically go one step further to establish a “nexus” to Delaware by hiring employees at an office to maintain those files in a “Holding Company”.
Delaware courts are very competent at handling disputes over intellectual property. Firms often select Delaware to hold intellectual property to make it more likely that a case over those assets will be brought into Delaware courts.
As a Valuation "Freeze" Entity
What one owns at the present time may be worth many times that upon the owner’s death. This asset appreciation leads to tax if the owner has a taxable estate (currently over $2,000,000). The Delaware LLC is the preferred gifting vehicle to freeze the value of that gift at present value to avoid the taxation on the future appreciation. The property may be held in the name of an LLC with non-voting interests given to gift recipients. The value of that fractional interest is frozen as of the time of the gift. This is referred to as a Family Limited Liability Company or “FLLC.”
Gifts of LLC interests must confer a present economic benefit upon the donee in order to qualify for exclusion from federal gift tax; the measure of economic benefit to be derived from an LLC interest is dependent upon the alienability or control a member has over his interest under the operating agreement of the LLC. Hackl v. Commissioner of Internal Revenue, 118 T.C. 279, 2002 WL 47117 (U.S. Tax Ct.) Affirmed at: 2003 U.S. App. LEXIS 13936 (July 11, 2003).
Traditionally this has been done by gifting property directly to a limited partnership described as a “Family Limited Partnership” or “FLP.” The limited partnership requires at least one general partner to run the entity and at least one limited partner to serve as passive investor. Personal liability may result from assuming the responsibility of general partner. Also, personal liability may result when a limited partner assumes too much management control over the FLP.
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As an Estate Planning Vehicle for Gifting
Gifts of up to $12,000 per calendar year per recipient are exempt from reporting on a gift tax return. (Note: the unlimited marital deduction allows for unlimited gifting to a spouse). Each spouse is entitled to this exclusion without using up any of his or her $1,000,000 lifetime gift exemption. Therefore a married couple can give away up to $24,000 per year to each of the objects of their affection without having to report the gifts on a gift tax return.
Gifts may be made of an LLC interest. Non-voting LLC interests are one way to leverage this giving. Non-voting LLC interests are entitled to a discount for lack of control premium and non-marketability.
For example, an LLC can have one voting interest and ninety-nine non-voting interests. With real estate held by the LLC valued at $1,000,000.00, the fractional interest of each unit is $10,000.00. Rather than be limited to giving 2.4 units to the donee, the donor couple could give three units per year to each donee. The $30,000 interest subject to a reasonable 30% discount would bring the present gift value down to $21,000.
A discounted valuation opinion should be obtained from a hand-selected appraiser, emphasizing such attributes as lack of management control and limited transferability. The value of an interest in a company is the fair market value, subject to discounts and premiums.
Should the donor couple wish to leverage the gift even further, then they could give the 99 non-voting units to three donees. The reportable value of that gift could be then reported as a gift, not of $990,000, but rather ($990,000 - ($30,000 x3)) (70%) = $540,000. Each spouse has a one million dollar lifetime gift exclusion. Therefore the gift could be split and only $227,000 would need to be reported on each spouse’s gift tax return. Again, it is wise to seek a valuation opinion if this method of gifting is to be used.
The IRS has three years to challenge the value of this gift once reported if all the appropriate valuations and disclosures are reported on the return. Gift tax returns supported by valuation opinions tend to be audited less frequently than estate tax returns. In addition, the couple donor does not lose management control over the assets while they are alive and can title their one percent interest in the name of each of their revocable trusts to avoid probate in Delaware.
Since gifts made more than three years before death are “tax exclusive” the value of the gift does not include the amount of tax. If property is devised at death the estate tax is “tax inclusive” which requires the tax to be paid to be included in the size of the gift. The economic result, effectively, is a reduction in the applicable tax rate. This has been described as “driving a truck” through the estate tax.
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To Hold Life Insurance Policies
Buy-Sell Agreements in family owned businesses are often funded by cross-purchase insurance. Instead of each owner owning a policy on the other owners, an LLC can be set-up to own the policy. The surviving insureds form and operate an LLC. Using an LLC entitles the business owners to a “step-up” in basis to the date-of-death value of the business interest owned by the decedent. For example if a business has four equal owners and a value of $1.2 Million, the three surviving owners will each receive $100,000 worth of stock from the $300,000 life insurance proceeds usually paid to the estate of the decedent. The basis in the stock for the additional fractional interest acquired as a result of the decedent’s death would then be $100,000. This favorable tax treatment may reduce the ultimate capital gain on the future sale of a company interest. This is not available in most other cross purchase arrangements.
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For Venture Capital Projects and Corporate Joint Ventures
The LLC is well suited for venture capital fundraising and joint corporate ownership. The profits and losses of an LLC can be distributed disproportionately to ownership if agreed by the members, and with a pass-though taxation (without the restrictions of an S-Corporation). The owners of an LLC receive a K-1 to account for their interests, but there is no tax paid by the LLC on the partnership return 1065; instead, the tax is paid by the owners.
The LLC Operating Agreement can also serve as a subscription agreement, which provides for a complex ownership structure with maximum flexibility. Corporations have many rules about annual meetings, the contents of a Certificate of Incorporation, and certain restrictions placed on stock transfer. The LLC Operating Agreement is a good way to cut through the corporate requirements and restrictions without getting tripped-up on restrictions and formalities.
Additionally, entities cannot be the directors of a corporation; however, a member and/or manager of an LLC can be another LLC or corporation. Furthermore, an LLC operating agreement can waive all fiduciary duties that cannot be waived in a corporation.
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In Lieu of Corporate Subsidiaries
Prior to the LLC introduction, corporations set up their subsidiaries as corporations also. Corporate tax filings can be very complicated, not to mention the corporate management bureaucracy. Filings for LLCs are much less complicated and easy to separate businesses into separate LLCs. No annual meetings are required for an LLC. Although the business liability of the LLC is separated from its corporate owner, the LLC is a disregarded entity for tax purposes, avoiding an additional tax return for the corporate owner.
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Using the LLC for Professional Organizations
LLCs are flexible and easy to operate, which makes them appealing for professional firms. Unlike the LLP, the LLC does not require the individual members to be personally liable for their personal actions, nor does the LLC require that the name of each limited partner be filed with the Secretary of State. Unlike the Professional Association, the LLC does not require the owners to elect new directors on a regular basis. This avoids some of the time required to manage the professional organization and the possibility of power-struggles at regular meetings.
The professional organization set-up as an LLC may also elect to be taxed as an S-Corporation. In an LLC taxed as an S-Corporation, only the salaries would be subject to the FICA taxes, at the same rate as self-employment tax. Any remaining profits would be distributed as S-dividends and would only be subject to income tax but not to self-employment or FICA taxes. This treatment is contingent upon the amount and portion of salary compensation paid not being unreasonable low.
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Circular 230 Tax Disclaimer:
In accordance with Circular 230, the content of this publication is not to be relied upon for the preparation of a tax return or to avoid penalties imposed by the IRS Tax Code.
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