Two longtime friends, Bob and Tom, get excited about an idea and decide to go into business together.
Bob and Tom have heard that having a limited liability company (LLC) can provide them with liability protection and preferential tax treatment. Naturally, Bob and Tom decide to file articles of organization with their secretary of state’s office and start their business. (For the purposes of this story, let’s assume that Bob and Tom form their LLC with partnership taxation.)
So far, Bob and Tom have taken the proper steps, but normally, business owners go no further in formalizing their business. From here, the Bobs and Toms of the world say things like:
“Why have a company meeting? We’re the only two who work here.”
“Online legal documents are all we need.”
“I am the business, so what if I move money from the business account to my personal account when I want to? It’s mine anyway.”
“My fishing boat is a business expense, right?”
Separation Anxiety
In the immortal words of ESPN’s Lee Corso, “Not so fast, my friend!” An LLC affords its members liability protection and preferential tax treatment because it is a separate entity from its members.
In situations where the members do not keep the separation between the business entity and its members clearly defined and properly documented, courts can find the LLC to be a mere alter ego of its members. Members can find themselves personally liable to the IRS, other members, investors, vendors and customers.
Members need to take certain steps to help protect themselves from this unwanted outcome.
Eight Steps to Success
>> First, file the articles of organization.
>> Get an attorney to draft an operating agreement. The agreement should be specific to the state laws where the business is located, and it should be tailored to the needs of the members and the business. A good operating agreement will lay out the members’ investment and profits interest in the LLC. It also will detail who has authority to take certain actions, who has control of the LLC, and what happens when the members choose to split up—which will happen at some point.
>> Have an attorney draft a buy-sell agreement. The agreement will list how to respond when a member leaves, becomes disabled, dies or is expelled from the LLC.
>> The members must hold annual meetings and take minutes of these meetings. That way, the LLC can ratify the actions of the members and provide additional proof of company formality.
>> Apply for an employer identification number for tax purposes; you can file an online request with the Internal Revenue Service at 1.usa.gov/18bJ7JL. And remember to pay your taxes.
>> File annual reports in Kansas. (Missouri does not require annual reports for LLCs.)
>> Be sure to include LLC after the company’s name as this puts the public on notice of the company’s limited liability.
>> Lastly, keep the LLC’s money and the members’ personal money separate from each other, document transfers, and do not use company money to pay for members’ personal expenses.
Owning a business is the American dream, but if entrepreneurs want to preserve the liability protection and preferential tax treatment that LLCs afford them, then they must act to protect the business’s status as a separate entity.
