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Wednesday, June 29, 2011

What is an LLC and Why Do I Need One?
 1. What is a Limited Liability Company?  

A limited liability company or “LLC” is a business entity that is authorized by specific legislation in most States and in many foreign countries.  It is designed to offer co-owners of an unincorporated business who make a proper filing with the state freedom from personal liability for the debts of the business, the option to manage the business, and the tax advantages of partnership status.  The owners enjoy limited liability, and are not vicariously liable for the contract or tort obligations of the business.  The LLC can be member-managed or manager-managed. Simply put, the LLC combines the best attributes of a corporation and a partnership 

 2. How do you form an LLC? 

An LLC is formed upon the filing of a document, generally called “articles of organization,” with the secretary of state or some other designated state office. The articles of organization are normally very simple providing only basic information with respect to the name of the company, the agent for service of process, the company’s address, and its manager(s) or member(s).

 3. How is a LLC Structured? 

An LLC is structured much like a partnership, with the co-owners being referred to as members instead of partners. The LLC can be member-managed in a manner similar to a general partnership or it can be manager-managed like a general partner does in a limited partnership. If the LLC is member-managed all members will typically have an equal vote and collectively make decisions.  This includes not only major business and financial policies, but also the everyday operations. If the LLC is manager-managed, the members only decide on major financial and business decisions and the manager handles the day-to-day business operations.

 4. How is the structure of the LLC determined? 

The founding members or promoters of the LLC determine the structure by means of an operating agreement which is similar to a partnership agreement.  Typically, when the articles of organization are filed, the state requires the articles to include the management structure.  That is, whether the LLC is member-managed or manager-managed. The members have an experienced attorney draft an operating agreement which sets forth the different rights and responsibilities of the members and covers matters such as capital contributions, division of profits, management, member meetings, transferability of ownership interests, dissolution, and indemnification. An LLC is a contractual entity, with only a few mandatory, non-waivable provisions. 

 5. What are fees for establishing and operating a LLC? 

Forming an LLC costs money. However, these costs vary somewhat significantly from state to state.  The total cost of establishing an LLC is totally dependent upon each situation and the professionals that are involved.

 6. Tax and Accounting Treatment 

Recent changes in federal tax law – known as the “check-the-box” regulations – have allowed LLCs to choose between taxation as a partnership and corporate taxation.  In most instances it is better to be taxed as a partnership. When electing to be taxed as a partnership the LLC files an Information Return and issues K-1 statements to its members.  The K-1 shows the member’s share of the income or loss that the LLC incurs. The members then report this amount on their individual returns. The LLC, if taxed like a partnership, does not pay any income tax. If the LLC is a single member LLC, the owner may treat it as a disregarded entity for tax purposes and report the tax and related accounting on the individual tax return of the member. This eliminates the necessity of a tax return for the LLC.

   7. Charging Order Protection 

Creditors of members of an LLC can obtain relief through what is known as a charging order.  This means that the creditor can get an order requiring the LLC to remit to the creditor any distributions that would otherwise be made by the LLC to the judgment debtor whose interest is being charged. This remedy precludes a judgment creditor of a member from obtaining a seizure and forced sale of the debtor-member’s interest in the LLC while at the same time providing the creditor some relief relative to distributions from the entity to the member. The charging order remedy is often times the exclusive remedy available to the creditor and provides substantial asset protection for the LLC owner.


The charging order limits the creditor exclusively to collection of the income or distributions which the LLC assets might engender, but which under some circumstances can be withheld from distribution at the discretion of the LLC manager. Stated another way, a creditor who has obtained a charging order only has the right to receive distributions from the entity when and if such distributions are made even though the entity itself may have substantial income.

 8. Holding Real Estate in the LLC. 

If the primary purpose of the LLC is to hold title to real estate investments, the members will need to deed or convey the real property to the LLC by means of a formal, recorded deed. All of the rents with respect to the real property should be deposited in the LLC bank account and all expenses with respect to the property should be paid from the LLC bank account. All contracts with respect to the real property and service arrangements should be exclusively in the name of the LLC.

 9. Examples. 

The following are some examples of when and why a LLC might be wisely selected:


a. Jean Nakamura is a widow, who in addition to her residence, owns a four-plex in Kailua, Hawaii. She is concerned about potential liability above and beyond her insurance coverage and has elected to place the four-plex into an LLC of which she is the single member. She treats it as a disregarded entity for tax purposes and all of the tax and accounting are reported on her individual Return.


b. Dave Carson, his brother Bill and their friend, Richard, each own a one-third interest in a small shopping center in Haleiwa, Hawaii. They have created an LLC in which to hold title to the shopping center so as to protect their respective personal assets from any claims with respect to the shopping center. All three of them participate equally in the LLC which is member-managed by the three of them and treat it as a partnership for tax purposes. The LLC files a partnership return; Dave, Bill and Richard each receive a K-1, which they use to prepare their individual tax returns.


c. Kawika Wilcox, owns a 25% interest in a 76 unit apartment building which he manages in Kihei, Maui. The other 75% is owned by various members of Kawika’s family and by some friends. Kawika and the other members have placed the apartment complex into a manager-managed LLC to provide Kawika greater flexibility in his management duties and responsibilities. The LLC reports its taxes as a partnership and Kawika and all the other members receive K-1s for their shares of profits.  Kawika also receives a salary or guaranteed payment as manager which is paid to him as an expense before there is a division of profits.


d. LLCs can be used to operate any retail or other business in situations where limited liability is desirable, but the flexibility of the LLC is required.

3:41 pm hst 

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