The Limited Liability Company (or LLC) is a hybrid entity. It combines the limited liability of the corporate structure with the benefits of being treated as a partnership.
Because of that, the LLC has come to be the most common entity selection among startups, small or large, because of its simplicity and its flexibility.
Once you have your LLC formed, it is important to maintain the organization and ensure compliance with regulations and state laws, so you do not lose your liability protection. Just because the LLC is simple and easy to maintain, does not mean that legal compliance will happen without paying attention to your LLC. Here are some of the legal issues you may encounter with your LLC.
Annual Business Privilege Tax
In addition to state, county, and city business licenses, Alabama, requires every new entity formed to pay an initial Business Privilege Tax within 2.5 months for forming. This tax is also assessed every year in April. The initial Business Privilege tax is designed to ensure the state of Alabama receives its money in the initial year of a business existing. It is not prorated. That means, you must pay $100 for the year you file whenever you file. If you file right at the end of the year, you will be required to pay the initial return within 2.5 months of filing and the annual return in April of the following year. The initial business privilege tax is imposed on formation. The annual business privilege tax is imposed for each additional year of operation. This is a relatively simple form and can be completed relatively quickly. If, however, you are working with an accountant, you may want to ask them to put it together for you.
Taxation for an LLC
The LLC has even more flexibility than the C versus S Corporation on how it is taxed. The IRS has something called “Check the Box” provisions that allow, specifically the LLC to be taxed in a way chosen by the owners. That means the owners have the flexibility to adjust the tax structure for the current needs of the business.
LLCs are, by default, taxed as a partnership (for more than one owner) or a sole proprietorship (just like your personal taxes). You can, however, elect to be taxed as an S Corporation or a C Corporation.
LLC’s are, by default, not only taxed as a partnership, but they are to be treated as a partnership, which is simpler than the S Election and the restrictions on S Corporations are nonexistent. This allows the LLC to be functionally whatever it needs to be. The LLC, like the partnership, is a creature of contract. That means, it can do what it needs to do. You can take investors how you need to, you can structure ownership how you need to. It can look as creatively as you (and your lawyer) want it to be. I have seen some neat things done with the LLC.
Though this seems to be a tax issue, making tax elections can have legal consequences that affect the structure of your LLC. Before you make any changes to the tax structure of your LLC, you should consider both the immediate tax impact and the legal impact of your election.
LLC Operating Agreement
The Operating Agreement is a contractual agreement between the owners of the LLC. The Operating Agreement, depending on your tax election, may also need to serve as the Bylaws of your company. The Operating Agreement should state the non-negotiable between the owners and outline the way the business is to be run.
No matter how carefully you craft your Operating Agreement, it is always important to revisit the bylaws regularly to make sure they reflect the way the Corporation is actually run.
Restriction on Equity Transfers in an LLC
Whether it is in the Operating Agreement or a separate agreement, it is always important to consider the impact the personal lives of the owners may have on the company. The important part of all of this is that you must plan ahead. If you wait until your partner is going through a divorce or bankruptcy, it will be too late to keep your business out of it. If, however, you do plan ahead, these unplanned events that cause problems and stress in the life of your partners will not create the same level of problems and stress in your business.
Don’t forget, if you haven’t come up with a way to fund these events, the buy-sell agreement can cause more harm than good. If you have a liquidation event for a member’s equity in a divorce, but you can’t pay it, you have not solved your problem. You have created a new one. Now, your business owes money that is being divided in litigation between two separate parties in litigation that you are not a part of. This is not good.
Governing Meetings and Minutes
Though not an absolute requirement in LLCs, there is no question that meetings and documentation of decisions made by the owners is an integral part of protecting yourself from liability. It is a good idea to have, at least, an annual meeting with documentation of any decisions made or ratification of decisions made by the owners or managers. In addition, if there are any big decisions to be made, it is always a good idea to document the opinions of all of the voting owners related to that decision. This can avoid confusion or questions down the road.
Documenting Your Operations
Of course, formation is not the only legal protection available to a business. I tell everyone who asks me how to best protect their business that they should make sure every relationship where money, products, or services are exchanged should be documented in writing. In some cases, the relationships cannot be anticipated and you must consider the best way to document a relationship that develops. At this stage of your business, there are a few relationships you know you need to document. In many cases, you can develop agreements that will work in most instances of that type of relationship. In other cases, you need an agreement for a specific relationship.
Some common types of agreements and relationships are outlined below.
- Employment Agreement or Handbook– In the early stages of a venture, an employee agreement may be all that you need to protect your company in the hiring of employees. If, however, you plan to hire on a more regular basis, it would be beneficial to look into an employee handbook. The benefit to a handbook is that ALL employees agree to it and it can be changed at any time. If you have each of your employees sign the agreement, you have to change ALL of the agreements whenever you make changes. A handbook is global and applies to ALL employees and is adjusted at the same time with notice. Don’t forget to have a system for progressive discipline of your employees.
- Independent Contractor Agreement – Independent Contractors are such a great way to help a business scale the way it needs to. The independent contractor relationship can help a young company find some of the best talent at the lowest possible cost. It can also allow a business to use talented people for the time when it needs them, without complicated employment laws and taxes lowering the money they can offer the worker who deserves it. It is, however, very important that the Independent Contractor relationship is properly documented and managed to avoid the IRS calling the Independent Contractors employees and demanding back taxes.
- Online Agreements – If you have any kind of online presence and you gather any information online, you will need online agreements to protect your business and give the proper notifications regarding privacy to those who visit your site. The basic agreements are:
- Client Agreements – Whatever type of service you offer, you should have your relationship documented. Your client agreement should work with your business systems and protect you in the event you need to collect unpaid fees from your client. This is one of the most important, and most valuable, legal documents you can have in your business.
- Vendor Agreements – Whether you create them or you review them, you want to make sure your relationships with your vendors are documented. It is difficult to enforce your rights if you are not certain what the agreement stated.
Above are some of the most common types of agreements you may encounter. when you are planning your business and figuring out what relationships you have with the outside world. In most cases, your relationships might be broken down into those who are paying you and those who you pay. No matter what your business, you have relationships like these. Are they documented? Have you reduced it to writing?
In some cases, such as in retail, you are not going to get a signature every time someone buys something from you. So, how do you document the relationship? How do you let your customers know what happens if checks are returned or if they need to return something? These are elements of your agreement with your customer. As you develop the systems in your business, you need to think about how to reduce those relationships to writing.
Legal is everywhere in your business. It impacts every aspect of your business. Even when you create an LLC to limit the liability of an owner, you should consider how to limit the liability of the LLC. After all, it is best to avoid a law suit altogether than to protect yourself from the loss of one.