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A new LLC option

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Limited liability companies have become one of the most desirable forms of doing business. An LLC is a hybrid between a partnership and a corporation in that it combines the "pass-through" treatment of a partnership with the limited liability accorded to corporate shareholders.

The LLC concept originally came to America from Germany. Wyoming became the first American state in 1977 to enact a true LLC act modeled after the German model. The Wyoming LLC Act permitted the formation of LLCs organized for any lawful purpose except the business of banking and insurance. Many other states quickly followed Wyoming's lead. There were a variety of very good reasons for the popularity of this business entity, including:

  • Separate legal entity: Like limited partnerships and corporations, an LLC is recognized as a separate legal entity from its "members."
  • Limited liability: Ordinarily, only the LLC is responsible for the LLC's debts, thus shielding the members from individual liability. This is, of course, unless an LLC member has personally guaranteed the obligations of the LLC or the LLC member personally caused the liability.
  • Alter ego liability: The judicial doctrine applied to corporations where a court may hold the individual shareholders liable where the business entity is merely the "alter ego" also applies to LLC members. However, while a corporation's failure to hold shareholder or director meetings may subject the corporation to alter ego liability, this is not the case for LLCs in California, as the usual corporate formalities do not apply.
  • Management and control: Management and control of an LLC is vested with its members unless the articles of organization provide otherwise.
  • Voting interest: Ordinarily, voting interest directly corresponds to interest in profits, unless the articles of organization or operating agreement provide otherwise.
  • Transferability: No one can become a member of an LLC (either by transfer of an existing membership or the issuance of a new one) without the consent of members having a majority in interest (excluding the person acquiring the membership interest) unless the articles of organization provide otherwise.
  • Duration: Although many states now allow an LLC to have a perpetual existence, LLCs traditionally were required to specify the date on which the corporation's existence will terminate. In most cases, unless otherwise provided in the articles of organization or a written operating agreement, an LLC is dissolved at the death, withdrawal, resignation, expulsion or bankruptcy of a member (unless within 90 days a majority in both the profits and capital interests vote to continue the LLC).
  • Formalities: The existence of an LLC begins upon the filing of the Articles of Organization with the Secretary of State. The articles must be on the form prescribed by the Secretary of State. To validly complete the formation of the LLC, members must enter into an Operating Agreement. This agreement may come into existence either before or after the filing of the Articles of Organization and may be either oral or in writing. In 1994 California passed legislation creating the state's version of the limited liability company. California acted in response to the measures taken by other states. As a general rule, California has not been on the cutting edge of business-friendly legislation. It wasn't until 1987 that California recognized S corporations. Perhaps the only exception is that while most states require an LLC to consist of two or more members (owners), California allows for a single-member LLC.

    California taxes all LLCs doing business in California an annual $800 minimum tax, as well as according to an additional fee structure. This fee is $900 for total annual gross income between $250,000 and $500,000; $2,500 for gross income between $500,000 and $1 million; $6,000 for income between $1 million and $5 million; and $11,790 for income more than $5 million.

    Because of this fee structure, a major problem has developed for California LLC owners. Individuals using multiple limited liability companies are subject to state-based LLC fees and minimum taxes that are higher than what they would be obligated to pay using a different type of legal entity. Some authors have suggested the use of California limited liability partnerships as a solution. Though for a number of reasons, an LLP may not work as well as an LLC.

    Fortunately, an attractive option has surfaced. The state of Delaware has created an LLC with sub-LLC components or divisions. Each division stands alone for liability purposes under Delaware law. While this sub-LLC approach is a new concept, attorneys who have dealt with Delaware LLCs believe California will honor the separate liability structure under the "full faith and credit clause" of the U.S. Constitution. Thus, if properly established and maintained, any adverse legal liability situation for one division will leave the other division unaffected even though there is only one legal entity.

    The requirements for this new entity are simple. Each sub LLC or division must be named in the Certification of Formation at the time of organization. Accounting records must be separately maintained for each division. Because Delaware considers the new LLC a single entity, any fee costs to the state of California should be limited to those of a single entity, i.e., one $800 minimum annual tax and a gross receipts fee based upon the entire entity's gross income.

    I was recently made aware of this new option by attorney Rob Butterfield, of Butterfield Schechter LLP. If you have any specific questions, contact him at (858) 444-2300 or rbutterfield@bsllp.com.

    Burson is a partner with Grice, Lund & Tarkington LLP. He can be contacted at bob.burson@sddt.com.

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