10 Things to Avoid Doing with an LLC - dummies

By Jennifer Reuting

LLCs (limited liability companies) are pretty powerful entities that you can do some pretty amazing things with. But you know how the old saying goes: “With great power comes great responsibility.” In other words, if you don’t watch out, you can get yourself into trouble.

Fraudulent conveyance of assets

If you just got sued and want to protect your assets, I’m sorry to say that it’s too late. If you were to transfer your assets into an LLC, you would be fraudulently conveying them. According to the law, you are fraudulently conveying assets when you do one of two things:

  • Sell or transfer the assets at less than fair-market value, which results in a creditor being defrauded

  • Transfer the assets so a creditor can’t seize them to recoup his claim

Fraudulent conveyance is a civil offense and can cost you a lot more money in the long run than if you were to just hand over your possessions. If you formed an LLC with the intent to defraud a creditor (as opposed to forming an LLC not knowing that your assets were immediately at risk), you’re even worse off. Not only will the creditor still be able to get your assets, in some states, you may be subject to penalties and even imprisonment. Futhermore, federal laws say knowingly committing fraudulent conveyance can be a criminal offense.

You can even unknowingly fraudulently convey assets. This can happen when you’re setting up your asset protection strategy and transferring your assets into an LLC or two, and little to your knowledge, a lawsuit is already pending against you. Even though you don’t know about the pending lawsuit, the assets still have been fraudulently conveyed. You probably won’t get criminal charges in this instance, but you still may be required to turn over the assets that you thought were protected.

Evading taxes

Although it’s prudent for you to take every action within the law to reduce your tax burden, actually evading taxes is a huge no-no. Tax evasion is when you dodge paying taxes by illegal means. Tax avoidance, on the other hand, is perfectly acceptable and legal. This just means that you legally reduce the amount of tax that you owe. For instance, putting your retirement savings in a Roth IRA, which allows you to defer taxes, is considered tax avoidance. It’s a perfectly legal way to reduce your tax burden.

To determine whether you are avoiding taxes or evading them, remember this: Tax avoidance occurs when you avoid the creation of tax liability in the first place. However, you’re guilty of tax evasion when you have done something to owe taxes and you don’t pay them. Then you’ll probably end up in jail.

The scariest thing about tax evasion is that it’s a criminal offense — a felony — which has no regard for how much tax you even evaded. Evading $500 in taxes is the same as evading $5 million in taxes in the eyes of the law (although, one hopes the judge will be more lenient in the former case).

Choosing a bad partner

Partnerships are like marriages — you should jump into them with your eyes open. Fifty percent of marriages end in divorce, and the numbers are much worse for business partnerships. This shouldn’t be a deterrent — after all, when you have a partner whom you work well with, your efforts are compounded tenfold. You just need to make sure that

  • You know the person whom you’re going into business with.

  • You have policies and procedures to go by when disagreements come up — and they will come up.

When you’re first getting into business, you’ll sit down with your partner and agree on where you both want the company to go and what you want your ownership percentage and different roles to be in the company. The problems usually occur many years after inception, when your or your partner’s life goes in different directions. For instance, you may want to expand into a new market, but your partner is happy with the income he has and just wants to let the business coast along. Or your partner needs cash and wants to sell out, but you don’t have the money to buy out his share. In these moments, you need to have a plan to follow.

You need to have a partnership agreement, which can be a part of your operating agreement. You must take the time to sit down with your partner and plan your partnership all the way to the end.

Ignoring the bureaucratic paperwork

State filings, tax returns, permits, and so on — they’re all time consuming, bureaucratic, and you hate doing them. Trust me, you’re not alone. But unfortunately, it’s imperative that you don’t drop the ball and that you stay on top of these things.

This especially goes for state filings. Here’s the thing: Your LLC is registered under the laws of the state, and that which giveth can taketh away. If you don’t keep up with your filings, the state will revoke your LLC, and you’ll (often unknowingly) be operating as if you were a sole proprietorship. You’ll have zero liability protections if you get taken to court.

Trademark infringement

Infringing on another company’s trademark is one of the easiest pitfalls in business and can end up costing you a fortune. Be cautious about trademark infringement because not only can you fall into this trap without any knowledge of it, but a lot of Fortune 500 companies hold hundreds of trademarks each. They have attorneys and paralegals who spend their days scouring the Internet and local communities for small businesses that may be infringing on a trademark they own. The company is then nice enough to send a cease-and-desist letter.

When you receive one of these letters, you have two options.

If you’re an upstart and don’t have a lot of money wrapped up in the name that the company is disputing, stop using the name and choose another one.

If you have spent a lot of time and money marketing the name and feel as though you have the right to use it and that it doesn’t confuse consumers in any way, then you may want to consider hiring a good trademark attorney. Your trademark attorney can point you in the right direction. Just keep in mind that if you end up going to court, you’ll be shelling out lots of dough, especially if your opponent has much deeper pockets.

Not creating an operating agreement

Even though operating agreements aren’t legally required, you’d be absolutely crazy not to have one! LLCs can make up a lot of their own rules — you just have to put them in the operating agreement. If no operating agreement exists, then the state laws automatically apply by default. Letting your state government tell you how to run and structure your business isn’t a smart practice. You not only miss out on one of the LLC’s most major benefits — flexibility — but you also aren’t in control of your business.

Create a real operating agreement that is unique to your company, and then use it! You should read it over on occasion so you know your company’s policies when it comes to certain issues. If you decide to change your policies, that’s fine. Just make sure that you have a meeting with the other members and vote in the changes. Meeting procedures can be found in none other than your LLC’s operating agreement.

Not documenting company activities

LLC law is pretty lenient when it comes to keeping records, but don’t let it fool you. Documenting your company activities is still incredibly important. At some point, your business decisions will be questioned, and you’ll be relieved when you have your company minutes there to defend your reasoning. Not only this, but your company records prove that you do things by the book. So, if an angry member sues because he didn’t get his way at the last meeting of members, you can show that the proper vote was taken and that correct formalities were practiced.

Here are a few good reasons to keep your company records in order:

  • When applying for loans or creating other banking relationships, your record-keeping practices allude to your reliability as a business owner.

  • The most common lawsuits among partners in an LLC happen when one or more members disagrees with a course of action that another member has taken. By properly documenting your actions, you can prove that you went through the proper channels and made and acted upon decisions according to your powers as described in the operating agreement.

  • Should you ever wish to sell your company, take it public, or enter into a joint venture, you need to have all of your previous company actions properly recorded.

  • If you’re ever audited, the IRS will look at your corporate records to see your intentions behind various transactions.

Treating your LLC like a personal piggy-bank

This is really simple and really important: Only use your company’s money for company-related expenses. This sounds elementary, but it’s a common mistake and can cost you a lot in the long run — not only in penalties to the IRS, but it could also cost you your liability protection. It’s often tempting to write checks or use a debit card from whichever account has the most money in it — but don’t do it. Personal expenses that you’ll especially want to avoid are things such as your mortgage or groceries. Restaurant bills are okay, as long as the dining experience was business-related.

If you really need to pay for a personal item out of your company bank account, then do it. Just make sure that this doesn’t occur very often and that you properly document the transaction and classify it as a loan or officer income. If the transaction was a large one, then you’ll also want to document it in the company minutes.

Neglecting to foreign file

Transacting interstate business has gotten easier as the world has gotten smaller. Each state has a different idea of what “transacting business” actually means. Regardless, you’re still required to register to transact business (foreign file) in every state that you operate in.

Here are some questions to ask yourself to help you determine whether you’re transacting business in a certain state:

  • Does your LLC have a physical location in the state, such as a corporate office or manufacturing facilities?

  • Do you accept orders in, or originating from, the state?

  • Do you have employees (not independent contractors) in the state?

  • Do you have a bank account in the state?

Refusing to delegate

Some people trust no one to help them and do everything themselves. This is because, in their mind, no one can handle the job as well as they can. This is a disease of the self-employed, and it can weaken you substantially. Why? Because you can only do so much, and until you start to delegate, your organization will never grow — not to mention that you’ll most likely get burned out before you know it.

You have to delegate some things in business, or else you can get into some pretty big trouble. For instance, tax laws are incredibly complex, and unless you studied to be an accountant, there’s a good chance that if you handle your own taxes, what you don’t know will destroy you, especially if your business is on the larger side, has employees, and is somewhat complex.

The same goes for attorneys. Don’t try to represent yourself in court. Lawyers, although they can be expensive, are incredibly necessary to a small business. Don’t operate on assumptions — seek the knowledge of a competent lawyer when legal matters come up.

When handling your corporate filings, especially if you are registered in multiple states, have your registered agent assist you. Not only is a registered agent required by law, but he also has more knowledge and resources in corporate matters than you do. Use a registered agent who is part of a competent incorporating company. That way, you can save legal fees when seeking information about simple, non-complex corporate matters or getting answers about your filings.

Don’t be a jack of all trades. Master one thing, and then delegate the rest. For instance, if you aren’t so hot at sales, don’t worry! Hire a great sales manager and empower her to take the reins and build a phenomenal sales floor. Even if you are decent at something, find someone who is better than you and recruit him. When you find these people, take a leap of faith and don’t undermine them. After all, your business is only as good as the people in it.