The Alphabet Soup of Limited Liability Entities

Choosing a business entity requires sifting through various combinations of letters: L.L.C’s, L.P.'s, L.L.L.P.’s, Co.’s and Inc.’s. The oldest of all these entities is the corporation.

With a corporation, the shareholders have limited liability exposure. Generally, their personal assets cannot be reached if the corporation is sued or has a creditor. The corporation must represent itself as a corporation by using the designation of something like “Inc.” or “Co.” or “Ltd.”

Since the corporation has a double layer of tax (one at the corporate level and one at the income level for the shareholders), the tax law changed to allow an “S-corporation.” The "S-corporation" is a tax designation which allows the corporation to be taxed as a “pass through" entity. That is, there is no tax at the corporate level. Instead, the income passes through the corporation and the tax is assessed against the income of the shareholder. The "S-corporation" tax designation can now be applied to LLCs.

Partnerships are “pass through" entities with the taxes being assessed against the partners’ income only. A creditor of the partnership could reach the partners’ personal assets, unless the partnership is registered as a limited partnership, using "LP" in its name and then liability protection is given to the limited partners. If the partnership is registered as a limited liability limited partnership or a limited liability partnership and uses "LLLP" or "LLP" in its name, then the general partners can also be protected from the partnership's creditors.

Choosing an entity depends on a variety of factors, including size, type of business and tax preferences. If you are just one person in business providing services, then you likely want to have an L.L.C. or a corporation. A partnership still requires at least two parties; i.e., a party being a person, trust or business entity.

If you are going to have a lot of employees and/or sell a lot of "widgets," then a corporation provides better tax benefits and more retirement benefit options. If you are not going to be really large, but your company will bring in more income than what would be a reasonable salary for each of the owners, then an S-corporation may be preferable. Again, the "S-corporation" designation is a tax designation and can be applied to a corporation or to an LLC.

With an S-Corporation the company can pay the shareholder who works for the company a reasonable salary and the remainder can be distributed as dividends. Taxes are saved because employment taxes are paid on the salary not the dividends.

If you are a professional, including a real estate broker, then you need to have either a P.C. (professional corporation) or a P.L.L.C. (professional limited liability company).

If you want to operate a business with younger family members and give them ownership interests, then an L.L.L.P. or an L.L.C. would be used. The gift of the ownership interest has a discounted tax value which limits the gift taxes that are due.

Partnerships are registered with the Office of the Arizona Secretary of State while corporations and L.L.C.’s are registered with the Arizona Corporation Commission. The Arizona Secretary of State requires annual reports for all partnerships that have limited liability (L.L.L.P.’s or L.L.P.’s).

The Arizona Corporation Commission does not require L.L.C.’s to file annual reports, but corporations are required to file annual reports and keep annual minutes of the Board of Directors and the Shareholders for three years.

These are just highlights of the considerations for choosing a limited liability business entity. Further, every business should have liability insurance to protect against the expense of lawsuits as well as potential judgments.

Do You Trust Your LLC?

In these economic times, many people are forging into their own businesses and forming LLC's.  However, many people are forgetting to integrate their estate planning, specifically their revocable living trust, into their LLC.

The Arizona Corporation Commission requires a minimum to create an LLC; submit the requisite Articles of Organization, pay the filing fee and publish the Articles after being approved. This minimum does not protect you from having to seek court intervention if a Member of the LLC becomes incapacitated and does not avoid the need for probate if a Member dies.

If you have gone to the effort to have an estate plan, then be sure that your Member's interest is titled in your trust.  By having your Member's interest held in trust,  if you become ill, incapacitated or die, your Successor Trustee can act on your behalf and you can avoid court involvement in such a situation.

If the LLC is Manager managed, then the Manager should also be the Trustee of the trust. For example, the Member and the Manager should be listed as "Jane Doe as Trustee of the Doe Revocable Trust Dated February 3, 2008."  (The date the trust agreement was signed becomes part of the name of the trust.)

If a husband and wife own the Members' interest in their joint revocable trust, then the Members can be listed as the co-trustees of the trust holding the interest for the benefit of each Member.  For example:  "Jane Doe and John Doe as Co-Trustees of the Doe Revocable Trust Dated February 3, 2008, fbo Jane Doe; and Jane Doe and John Doe as Co-Trustees of the Doe Revocable Trust Dated February 3, 2008, fbo John Doe." The "fbo" designation is not necessary for the Manager and you can list the Managers as "Jane Doe and John Doe as Co-Trustees of the Doe Revocable Trust Dated February 3, 2008."

Operating Agreements, while not required, are very helpful when a trust is involved. The Operating Agreement can include definitions for a Member and for a Manager that direct the Successor Trustee, as appointed by the applicable trust agreement, to have all of the rights to act as the Member or the Manager, as the case may be.

If a Member or Manager has a durable power of attorney for finances, many businesses and  financial institutions will not allow the named agent to act for a Member or Manager who is incapacitated.  These same institutions have been responsive to successor Trustees when a trust is involved and the Operating Agreement directs that the Successor Trustee have the same rights as the Member or Manager.  Further, having the Member's interest held in trust is the only way to avoid probate if the Member's interest exceeds the amount allowable to pass without probate.

What Business is it of Business Owner to Consider Estate Planning?

Why should a busy business owner worry about estate planning? What is estate planning anyway?

Estate planning involves the legal framework that can protect a business when a business owner becomes severely ill or dies. For example, if a business owner becomes ill or incapacitated, how does the business continue doing business? For a sole proprietorship, an agent under a durable power of attorney can run the business. However, if the business is a corporation or an LLC, then most banks or other business will not recognize the agent. Instead, they often will require a court appointed conservator before continuing to do business where the owner has become ill or incapacitated.

If the owner had a revocable living trust and the business ownership (such as shares of stock) were held in the name of the trust, then the successor trustee could step in and protect the business. The Successor Trustee’s authority is more traditionally recognized when a corporation or LLC is involved. That is, banks and other businesses will not require a court appointed conservator when a key shareholder becomes ill or incapacitated.

When the court is involved, then the illness of the business owner becomes public record. The business’ finances become a matter for the Court to review. A conservatorship results in the loss of privacy, additional cost and opens the business up to the attention of family members that perhaps have no business being involved.

Estate planning for a business owner is also important to clarify how the business will be distributed upon the business owner’s death. To avoid court involvement and probate when a business owner dies, a trust is necessary. The business owner can list who will be the Successor Trustee, to collect the assets, complete the business operations and then distribute the business to the designated family members and beneficiaries or sell the business and distribute the proceeds.

A buy-sell agreement is helpful when a business is owned by more than one person or family. A buy-sell agreement usually involves the business purchasing life insurance so the business can buy out the deceased owner’s share and the remaining owners can continue the business. This can protect the business owner’s spouse to make sure the surviving spouse has sufficient funds for support instead of relying on the business partners to continue the business and provide the spouse an income stream.

            Further, the business owner needs to be sure to have a health care power of attorney so that the proper persons are identified to take care of the business owners’ health care. If the business owner becomes seriously ill or incapacitated without a duly appointed health care agent, then there is no one with authority to assure proper health care for all the owner’s needs. If the business owner cannot get proper health care, then recovery can be delayed which can have a detrimental effect on the business.