Limited Liability Company (“LLCS”): The ins and Outs of LLCs

 Posted on August 23, 2022 in Business Law

A Limited Liability Company is a hybrid between a Corporation and a Partnership. A Partnership is when two or more people join together to establish a business. The benefit of a partnership is the flexibility of business arrangements. A partnership can be any written benefit that two or more people envision. The drawback to a partnership is the lack of limited liability protection. The benefit of a corporation is the separation between a person’s assets and business liabilities. A Corporation provides limited liability protection for their owners or otherwise known as “shareholders.”

1. Limited Personal Liability

In this article, we will examine the benefits of LLCs. The first major benefit that we will discuss is limited liability protection. Prior to incorporating a business, many entrepreneurs are sole proprietorships or partnerships. Generally, establishing an LLC is a sign of maturity in business. Limited personal liability is the benefit of limiting the business liabilities to the business (or LLC). An LLC creates a separate legal entity, which is distinct from its’ owners. As a separate legal entity, the business owners and its’ personal liabilities are distinct from the business.

Limited liability is the general benefit of an investor or owner of an LLC (or otherwise known as a “member”) having liability separation between their business and personal assets. There are exceptions to the general rule, which is why legal representation is important for owners of an LLC.

A. Exception to Limited Personal Liability

I. Piercing the Corporate Veil

Piercing the corporate veil is the term for courts providing an exception to limited personal liability. Piercing the corporate veil refers to the LLC members (or owners) or a shareholder’s personal liability for a company’s actions or debts. Courts generally allow “piercing of the corporation veil” when business owners have failed to follow LLC formalities or operate the business similar to a business.

Single Member LLCs are often a target for piercing the corporate veil because one owner uses their LLC like their own piggy bank. Simply put, the business owner commingles their personal and business funds and uses the LLC similarly to the manner a sole proprietor would operate a business.

   II. Illinois Consumer Fraud and Deceptive Business Practices Act

The second reason for piercing the corporate veil is fraudulent activity. In Illinois, the Consumer Fraud and Deceptive Business Practices Act (“Act”), 815 ILCS 5/505/1, et seq. is legislation designed to protect consumers. Consumers can be borrowers or another business owner.

The purpose of the Act is to protect against unfair methods of competition and deceptive business practice of a trade or business. The Act makes it illegal for a defendant to engage in any deceptive or unfair act or practice in the course of commerce. 815 ILCS 5/505/2; Totz v. Continental Du Page Acura, 236 Ill. App. 3d 891, 900 (2nd Dist. 1992). The Act provides consumers the ability to find a business owner or an LLC personally liable for consumers that have experienced unfair and deceptive business practices.

In most circumstances, a Limited Liability Company provides an investor and business owner with limited liability protection. However, there are exceptional circumstances where a business owner’s personal assets are exposed to a business credit such as a customer or consumer.

2.  Flexibility and Less Formalities

An LLC is a hybrid between a partnership and a corporation. The benefit of a partnership is flexibility and less corporate formalities. In contrast, a corporation has formalities and is more rigid unlike a partnership. A major benefit of an LLC is its’ flexibility such as allowing business owners flexibility to meet their business needs. The LLC still offers limited liability protection similarly to a corporation, but without the restraints. LLCs are not required to host annual meetings and their record keeping requirements are less stringent. In Illinois, an LLC must file an annual report with the Secretary of State. LLCs and Corporations provide similar asset protection benefits.

In the annual report, the LLC owners or attorneys must file an annual report and pay an annual fee ($75). The consequence of failing to file your LLC annual report is the State of Illinois will administratively dissolve or revoke your LLC registration. An administratively dissolved or revoked registration restricts an LLC’s ability to conduct business legally in the State of Illinois. The annual report allows a company to report changes to their address; name changes; and addresses and updates to the member and manager’s information.

One of the restrictions of an S corporation is one type of stock. An LLC does not restrict its’ owners to one type of membership interests. For example, an LLC may have voting and non-voting membership interest, which are attractive to investors and owners of an LLC.

3. Tax Advantages of an LLC

Unlike Corporations, LLCs offer the flexibility of picking their tax classification. LLCs have the flexibility of adopting the tax status of a sole proprietorships; partnerships; S corporations and C corporations. The Internal Revenue Service (“IRS”) presumes a single-member LLC is a sole proprietorship for tax purposes. Simply put, the LLC as a business does not pay taxes nor does it file a business return with the IRS. Rather, the sole owner of the LLC reports its’ profits and losses on their personal 1040 tax return.

In contrasts, multi-member LLC are automatically taxed and classified as partnerships. Like single-member LLCs, multi-member LLCs do not file a business tax return. Rather, the profits and losses of its’ members and owners are reported on each member’s tax return by filing out Schedule E (for self-employment purposes).

On the other hand, traditional C corporations are “double taxed” because the corporation files a business tax return, and the shareholders pay taxes on their dividends or distributions. The term “double-tax” means that the shareholders of an C corporation pay tax twice, at the corporate and personal level. Therefore, the term “double taxation” means there are two levels of taxes for a traditional corporation.

An S corporation is reserved for small business owners and avoids the double taxation of the traditional corporation. An S corporation is a term used for S corporations because it is defined by Subchapter S of the IRS tax code. An S corporation election is required and there are eligibility requirements such as the following (for the S corporation to be applicable):

• No more than one hundred shareholders
• Limited to one class of stock. If you have issued common and preferred stock, then a corporation is ineligible for the S corporation election
• Corporation must be U.S. Based
• December 31st must be your year-end calendar for tax purposes
• All shareholders must agree on the S corporation election
• Nonresident aliens may not be shareholders. Any U.S. citizen or resident alien may be a shareholder

4. Management Flexibility

In Illinois, there are two types of LLCs. The first type of LLC is a member-managed LLC, which are primarily operated by the members. Members are owners of the LLC. In Illinois, the LLC may be managed by its’ members or its’ managers. A member-manager LLC is when the members share in the management of the LLC. The second type of LLC is a manager-managed LLC. A manager-managed LLC is like a corporation because the members (or owners) appoint managers to operate the day-to-day operations of the LLC. Managers of an LLC have the responsibility for making business decisions and run the business operations of an LLC. A major benefit of an LLC is the ability to appoint non-owners to run the management of the LLC without giving them ownership control and liability. For instance, family-owned businesses are an excellent example of a business where the use of a manager-managed LLC is a wise decision. A family-business has the option of having one spouse own the business while the other spouse is complimentary to the business (as a manager versus an owner). An LLC Operating Agreement can give managers as much or little responsibility as possible when it comes to business operations. A manager may sell and lease property when an LLC resolution gives them the power and flexibility to sell and lease property.

5. Unequal Profit Distributions

LLCs could set-up flexible profit distributions for their owners. For example, two owners may have equal interests in an LLC, but share the profits distribution in an unequal manner. The key for flexible profit distributions is there must be a legitimate business purpose.

LLC Operating Agreements may allow “disproportionate” taxing of profits to allow investors to minimize their risk. Investors of an LLC are more likely to invest monies in an LLC if their risks are minimized. One strategy to minimize an investors’ risk is by allowing them to receive a higher percentage of profits for a specified time.

LLC Articles of Organization

The Illinois Secretary of State has a guide called “A guide for Organizing Domestic Limited Liability Companies,” which is an excellent resource. There are key business decisions required when thinking about organizing an LLC or otherwise called “Articles of Organization.” The LLC Articles of Organization is the process of forming an LLC in the State of Illinois. There are nine (9) major decisions that must be decided:

• Picking the LLC Company Name is the first decision. We recommend having several LLC names available in case one is unavailable. The LLC name must be distinguishable from another LLC’s name for registration purposes.
• Choosing the Principal Place of Business Address. The principal place of business is the location where the company shall keep corporate records such as the members and managers of the LLC; a copy of the Articles of Organization; and copies of federal and state tax returns and records.
• Effective Date of Articles of Organization. The effective date of articles of organization is typically the date that they are filed with the Illinois Secretary of State. However, an LLC may pick a date no later than 60 days after the Articles of Organization are filled with the Illinois Secretary of State’s Office.
• Limited Liability Company Purpose. The purpose of an LLC is a general statement that allows it to perform any business transaction that is legal in Illinois. However, the LLC’s owners may make the LLC purpose more specific.
• Duration of the Limited Liability Company. The duration of the Limited Liability Company is usually perpetual unless stated otherwise.
• Optional Provisions. Optional provisions are any provision that is set out in the LLC Operating Agreement, which is agreed along with events of dissolution.
• Management Structure. Management structure is chosen here. Most often we list the names and business addresses of the managers of the LLC and any member with the authority of a manager.
• Signature of Organizer: The organizer of the LLC Articles of Organization is the person or entity that incorporates the LLC for the business owners of an LLC.
• Registered Agent and Registered Office. The registered agent must be either:
  • an individual who resides in Illinois or an entity authorized to transact business in the State of Illinois
  • The Registered Agent is one of the owners or managers of the LLC but may be a key employee as well. The Registered Agent is the person or entity that accepts official legal notices and receives the annual report notices from the Secretary of State.

In conclusion, LLCs are valuable business entities, with a lot of complexities. LLCs are like an I phone or Android because most people fail to take advantage of the useful features and benefits. Contact Gateville Law Firm at 630-780-1034 to discuss your LLC and Business Needs. Or use the contact form.