The Formalities of Operating an LLC

When you establish a limited liability company (an “LLC”), you probably do so with the expectation that the LLC will accomplish certain tax and asset protection goals. It is not enough, however, to merely prepare the Articles of Organization and file them with the Secretary of the State. If you do not operate your LLC in a manner that respects its status as a separate entity, you run the risk of jeopardizing some important goals you have when you establish the LLC.

Below is a brief summary of certain formalities that are especially important for you to follow. Although this post is not intended to be a comprehensive review of every law or requirement related to a limited liability company, it highlights many of the important issues involved when operating an LLC. For specific legal advice, please refer all questions to your attorney.

Prepare an Operating Agreement.

The members of the LLC, if more than one, should enter into an Operating Agreement. The terms of the Operating Agreement will describe each member’s powers and authority, set forth the procedural rules to follow when scheduling meetings and making decisions, and describe the economic interests and voting rights of each member.

Keep LLC funds separate from personal funds.

Establish separate bank accounts and brokerage accounts in the name of the LLC. Obtain a taxpayer identification number from the IRS for the LLC and make certain the LLC accounts are opened with the LLC’s taxpayer identification number. Do not use the LLC accounts for your personal funds. Do not pay personal expenses from the LLC’s funds. “Perks,” such as a company automobile, must be authorized by the members of the LLC as set forth in the LLC’s Operating Agreement and used for business purposes. If “perks” are utilized for both business and personal purposes, you should consult your accountant regarding allocation of expenses and the possibility that such “perks” will be considered income.

Adopt arms length business formalities when borrowing from or lending to the LLC.

Do not informally borrow money from the LLC . While an LLC is permitted to lend money to its members, managers and officers, such action must be approved by the managers of the LLC pursuant to the terms of the Operating Agreement and state law. A loan made to any member should be adequately documented. The terms of any loan and its documentation must be carefully structured and prepared for both tax and legal purposes. Similarly, personal loans to the LLC should be documented and approved by the LLC’s managers pursuant to the terms of the Operating Agreement.

Make certain that customers and vendors recognize the LLC as the party to LLC transactions.

Make certain that the individuals and businesses with whom you conduct business know they are dealing with an LLC . All stationery, billings, telephone listings, business cards, signs, liability insurance policies, business licenses, credit cards, and the like should bear the LLC’s name. The Operating Agreement will identify the members of the LLC who are authorized to act for the LLC. Only members who have been so authorized should sign documents on behalf of the LLC. The signer should always note his position with the LLC on such documents. If you mistakenly lead someone to believe that they are dealing with you, as an individual, instead of the LLC , you may be held personally liable.

Make certain that members acting on behalf of the LLC have authority to do so.

The members of the LLC should approve, in writing, the LLC’s major transactions. The Operating Agreement will typically identify a range of actions that require approval of the members. Examples are:

(1) Amending the Articles of Organization.

(2) Electing Managers.

(3) Taking any action that would make it impossible to carry on the ordinary business of the LLC .

(4) Confessing a judgment against the LLC in excess of a certain amount set in the Operating Agreement.

(5) Filing a bankruptcy petition for or against the LLC .

(6) Lending LLC funds on terms inconsistent with terms described in the Operating Agreement.

(7) Borrowing in amounts that exceed limits expressed in the Operating Agreement.

Satisfy tax return requirements.

All tax returns should be carefully prepared and timely filed and tax obligations (for example, franchise taxes and business organization taxes) should be paid in a timely manner. You should consult with your accountant regarding the various state and federal tax requirements.

Satisfy state reporting requirements.

The LLC must file periodic reports with the Secretary of the State and pay filing fees. Such reports typically include the names and addresses of its managers, or if none, its members, and the address of its principal office. Such reports also include the identity of an agent for service of process.

Obtain sufficient capital for the LLC.

It is important that the LLC be sufficiently capitalized to engage in the business it is conducting. LLCs which are thinly capitalized are more likely to be viewed as mere shells, thereby losing their capacity to shield you from certain personal liabilities.

Respect the rules for allocating the LLC’s profits and losses and for making distributions.

The Operating Agreement will describe how profits and losses are to be allocated among the members of the LLC. Distributions from the LLC should be consistent with such provisions. Distributions to the members made from the LLC in excess of profits must be made as provided in the Operating Agreement.

Respect the management structure described in the Operating Agreement.

An LLC may be either manager managed or member managed. The members who have management powers and responsibilities generally have unilateral authority to conduct the following activities:

(1) Enter into and perform agreements for the LLC .

(2) Open and maintain bank accounts and investment accounts, and draw checks and other orders for the payment of money.

(3) Collect funds due to the LLC .

(4) Acquire, utilize for the LLC’s purposes, maintain and dispose of any assets of the LLC .

(5) Pay debts and obligations of the LLC .

(6) Borrow money or otherwise commit the credit of the LLC for LLC activities.

(7) Employ from time to time persons, firms or corporations for the operation and management of various aspects of the LLC’s business.

(8) Obtain general liability, property and other insurance for the LLC .

If the LLC is member managed, each member has the right to participate in day to day operations of the LLC. If the LLC is manager managed, the Operating Agreement will identify the manager or managers, who have exclusive authority over the day to day operations, while the nonmanaging members have no such authority.

Posted on 6/2/2012 by Richard S. Land, Member, Chipman, Mazzucco, Land & Pennarola, LLC.

Notice: To comply with U.S. Treasury Department rules and regulations, we inform you that any U.S. federal tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction, tax strategy or other activity.

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