An LLC as a legal liability firewall (Part 2)

June 9, 2016 - Posted by: admin - In category:

taxes - No Responses

It is important to start any venture the right way and the formation of a LLC is no exception. While it is sometimes possible to correct mistakes later, it is not always possible to undo all damages caused or save the money that was spent in cleaning up messes created by improper actions.

This is part of a multi-part discussion on limited liability company formation and operation. We started the discussion last time by noting that an LLC (which stands for limited liability company) was originally designed to do exactly what its name indicates–limit liability in the operation of a business. This leads to the obvious but important point that an LLC should have a valid business purpose. We ended with an introduction to the formation of a limited liability company under applicable state law. In other words, we started to talk about how one goes about getting an LLC in the first place and we observed that even though it is very much possible to undertake such formation work as a “do it yourself” matter, there is a difference in many instances between what CAN be done and what SHOULD be done. We will now continue with this step of formation.

I have many wise clients and professional colleagues who believe that formation of a new legal entity is something easily accomplished and they should save the “expense” of paying me or another attorney and just do it themselves. In my experience, one of the problems with this mindset is that the entity (whether LLC, corporation or other) often gets formed incorrectly.  What does that mean? When you are forming a new business entity (especially through the online option), you are required to answer a series of questions (actually, MANY, MANY questions) in the process. Very often a non-attorney (and sometimes even a CPA, financial advisory or other professional) is outside of his/her ability in understanding how to correctly respond to these questions and, as a result, the wrong information is conveyed to the applicable state agency as the new business entity is formed. Does this mean that the computer or the entity explode or otherwise have a serious problem right away? No, of course not. However, just consider the wisdom (or lack thereof) of giving incorrect or inaccurate information to the applicable state agency at the very outset of your business operations. Does this seem like a good idea? Further, the state agency will then (in many instances) convey the information entered in the business formation process to the tax department of that state agency (as well as the IRS) so that when the business and/or the business owner file tax forms and reports in the future, the state taxing authority (and the IRS) are then operating under a set of information and a series of assumptions which may or may not be correct and which may or many not be consistent with the intention and understanding of the applicable business owner. Again, while this does not necessarily lead to significant problems right away, it does set the stage for future problems. Pause for a moment and consider how much any of us want to cause possible problems with the state or the IRS? Why would you or I ever want to do something which could make us more likely to have an audit and/or otherwise raise a red flag with the applicable taxing authority.

Let’s now move forward in the process and assume that the business owner (and/or the accountant or financial adviser of the business owner) has wisely and corrected formed the new LLC, answering the applicable questions with 100% accuracy. In other words, let’s forget about the possible problems just noted and consider a very common scenario where the new legal entity has in fact been formed correctly. What now? Is that all to consider? Well, that would be it if you intended to close down your business and end operations of the same right after forming the new LLC. Since you didn’t form the new legal entity just to close shop and go away, you actually have many other important considerations on your hands. Most significant at this stage is the LLC operating agreement–or in other words, the rules which will govern the operation of your new legal entity, now and in the future.  We have previously written on the topic of LLC operating agreements and we will write more again very soon. In the interim, if you wish to learn about some basic LLC operating agreement concepts, please CLICK HERE.

Thanks for reading!

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