Operating Your Limited Liability Company (LLC)
After you form your LLC, you’re ready to start business operations, right? Not even close. Actually, your work has just begun. After you’re registered, you still have to complete the formation of your LLC by creating your operating agreement and making some very important decisions. Luckily, you can handle most of these things while you’re waiting for your filed documents to come back from the state, saving you time.
Operating your LLC is meant to be easy. For the most part, if you forget something or fail to document something in writing, the courts will go easy on you. LLCs aren’t like corporations, where a single misstep in following formalities can cost you your limited liability protection.
Although this paperwork isn’t nitpicked by the state statutes like corporation paperwork is, you still need it to maintain separation. Also, you can save yourself a lot of time, hassle, and potential legal battles by getting it out of the way and making your agreements as tight as a drum.
Creating your operating agreement
Think of your operating agreement as a sort of partnership agreement, except with much more power. Your operating agreement is the blueprint for your company. In it, you state your company’s policies on important matters, including
How the company will be managed and by whom
How important decisions are to be made
How profits are to be distributed among the owners
The responsibilities and authority of managers of the company
The membership information, including who is a member, what that person contributed, and what membership interest she has been assigned
Operating agreements are the best thing to have happened to the business world since the Internet. They make the LLC great because you can virtually put anything you want in your operating agreement. With the exception of some state requirements here and there, you can structure your LLC in any way you can imagine.
You make the rules, not the government or the IRS. You say how you want your business to run, and then you structure it accordingly. This all happens in the operating agreement.
Creating an operating agreement takes some time and planning, but it’s vital to the formation of your LLC. Deciding what you want to put in your operating agreement may take you and your partners a while. After all, you’re creating an infrastructure that needs to serve you for many, many years to come.
After you create your operating agreement, make sure that all the members and managers of the LLC sign it. Distribute a copy to everyone, and put the original in your company records kit.
Keeping books and records
Every company needs to have a records kit. In this kit, all the crucial company documents and information are stored and remain accessible to all interested parties. In the old days, a company records kit was normally a big leather binder with the company name emblazoned on the side. Nowadays, the corporate kit is usually housed online, always accessible to all the owners, wherever they are.
Whether your corporate records kit lives in the physical world or the virtual world, it serves the same purpose: to house your important company records, such as your filed articles of organization and company charter, your operating agreement, resolutions and minutes from any meetings or votes that take place, your membership roll, and your unissued membership certificates.
Although strict formalities aren’t required for LLCs, documenting decisions in at least a semi-formal way maintains that your LLC is a business separate from you as an individual. Otherwise, the courts could claim that your LLC is an alter ego, and you could still lose your liability protection.
One of the most beautiful features of an LLC is that it can elect any form of taxation it wants (assuming that it’s not a single-member LLC). This means that your LLC can choose partnership taxation, corporation taxation, or S corporation taxation. What flexibility!
The default taxation for LLCs with more than one member is partnership taxation, so this form is what you’ll be subject to if you don’t elect otherwise. With partnership taxation, the business’s profits and losses get passed on to the owners, who report their share on their personal tax returns.
These portions of profits and losses that get passed on to the members are called allocations. This type of taxation is commonly referred to as pass-through taxation.
Because the LLC itself doesn’t have to pay taxes, the IRS only requires you to file an information statement (IRS Form 1065) that states how the company’s profits and losses are allocated among the members. Additionally, the company issues each member an IRS form called a Schedule K-1 that includes the information they need to determine how much tax they must pay on their share of the company’s profits.
An LLC isn’t required to distribute cash to its members. However, the members are required to pay taxes on the profits (allocations) whether or not they receive distributions. When the company doesn’t distribute profits to the members, the members still have to pay taxes on them out of their own pockets.
This sort of “profit” is often referred to as phantom income. In other words, the profits the members receive are about as tangible as a ghost.