By Charles H. McClenaghan
It is very important that you treat your LLC as an independent and separate entity from your other affairs in order to maintain the protection from liability offered by an LLC.
Your LLC offers a number of advantages for you:
- Protection of assets from future creditors;
- Protection of other assets from any claims made against the LLC;
- Centralized management for future generations;
- Protect the assets against filed marriages;
- Facilitated transfers among family members;
- Obtain discounts for estate and gift tax purposes or for purposes of a sale to family members or trusts for their benefits.
However, improper treatment of the LLC can be disastrous. Life happens and things can go wrong. Others seeking money like the IRS, a divorce lawyer, or a creditor’s attorney may attack the validity of the LLC based upon the allegations that the Member has not treated his LLC as a separate and distinct business entity.
These attacks are usually based upon the following arguments:
- The creditor of the LLC treated his LLC as a personal cash register and failed to treat it as a business entity.
- Member did not follow the requirements set up in the operating agreement.
- Assets were not properly titled to the LLC or were commingled with personal assets.
- The LLC was created solely for tax or creditors avoidance, and did not reflect the reality of the creator’s actual relationship to the now gifted or sold interests.
To counter these potential attacks, it is critical that you treat this business as a business:
- The formal requirements of Ohio law in forming the LLC have been followed precisely.
- A federal tax ID number has been obtained and must be used.
- No long delays between the date of forming the LLC and funding the assets into the LLC.
- Assets used to fund the LLC should be actually titled in the name of the LLC.
- There should be no commingling of any LLC funds with personal funds.
- The LLC must have its own checking account. All income generated by the LLC assets should be deposited into this account, and all salaries, disbursements and other expenses should be paid from it.
- The LLC must be compensated for any personal use of an LLC asset by any of its members.
- The member(s) should not transfer all of their assets into the LLC. The LLC is a business and is not customary or reasonable for a person to have all of his assets in his business.
- The LLC should have an operating agreement (or a written declaration if it is a sole member LLC) and the guidelines set up in this document be followed by the Member(s).
- The manager has a fiduciary duty to the members. It is important that the manager respects these duties.
- The managing member should be paid a management fee. This fee should be “reasonable compensation” based upon services rendered, especially if such a fee is called for in the LLC Operating Agreement.
- After a member’s death, the LLC should continue to operate as the IRS will be able to argue that the LLC was created solely for tax purposes if it were immediately dissolved.
- Distributions should be made pursuant to the Operating Agreement, which usually requires that the disbursements be made on a pro-rata basis. All distributions should be made at the same time and in proportion to the ownership interests.
- Only the manger should run the day to day affairs of the LLC. If non-managing members are permitted to run the business, the IRS could argue that the LLC entity is not being respected.
- The LLC books and records should be maintained with care. Often CPAs handle these documents.
- If the LLC has elected to be taxed as a corporation, the manager of the LLC must file annual income tax returns for the LLC and ensure that the members receive a K-1 to attach to their income tax returns.
- Although minutes are not mandated by the Ohio LLC statutes, it is always a good idea to have minutes of LLC meetings preferably at least once a year.
- The manager should contact the insurance carrier insuring the assets of the LLC are correctly titled.
Adherence to the above rules goes a long way to deflect any argument made by the IRS, a divorce lawyer or a creditor’s attorney who is trying to get into the pockets of the LLC that the Company has not been operating in the manner necessary to maintain its protected status.
Proper treatment and maintenance of an LLC is an important part of overall protection.
If you have any questions regarding your LLC, please contact us.