Free Limited Liability Company Worksheet

Members of a member-managed LLC or managers of a manager-managed LLC, as the case may be, are the agents of the company, and have the "apparent authority" to bind the LLC for commitments to third parties. Members of a manager-managed LLC do not enjoy this "apparent authority." Because the Articles of Organization are filed in the public records, all third parties are deemed to have notice of the granting, or restricting, of the authority of members or managers.

On the other hand, whatever authority is granted to managers and/or officers within the Operating Agreement (assuming that it is not recorded) is not deemed to be known by third parties who deal with the LLC. Therefore, restrictions on authority in the Operating Agreement do not affect the "apparent authority" of members and managers unless the third parties have been provided with actual notice of the restrictions.

If the Articles of Organization and the Operating Agreement conflict with each other with respect to such authority, the Operating Agreement controls as to the members, but the Articles of Organization control as to third parties. If it is desirable to restrict such authority to certain managers or members, the Articles can include such a restriction, and, if filed in the state or county records, all relevant parties are deemed to have received constructive notice of the restriction. (Note that the Operating Agreement must be recorded if it, rather than the Articles, contains such restrictions.) This option provides some security against unintended transactions by heedless managers or members.

Members, managers and officers with "apparent authority" are deemed to have actual authority to bind the LLC for any acts carried on in the "ordinary course of the company's business." For unusual actions, the LLC will be bound only if there is actual authority created before the act or ratified after the act.

For example, assume that the Articles of Organization of Acme, LLC are recorded with the state's Secretary of State. They provide that the LLC will be managed by managers. Assume further that the Operating Agreement, which is not recorded, establishes the offices of President, Vice-President, Secretary, and Treasurer. A third party who intends to purchase real estate from the LLC, which is in the manufacturing business, should not accept a deed signed by the President, without more, because (1) the sale is not in the "ordinary course of business," and therefore there is not even "apparent authority" for the managers to sign the deed (the members should approve the sale), and (2) there is neither apparent authority nor actual authority "of record" that the officers are authorized to act on behalf of the LLC. The solution: the third party buyers should require a "resolution," signed by the members (who have the ultimate authority, of course) authorizing certain individuals to sign the deed.

Most LLCs seek to be taxed as a partnership or proprietorship instead of as a corporation. In order to accomplish this, prior to January 1, 1997, it was necessary to avoid the default characterization by the Internal Revenue Service (IRS) that the LLC should be taxed as a corporation. Therefore, state LLC statutes tried to distinguish LLCs from corporations. The IRS determined that the following four characteristics define a corporation:

• Limited liability
  
• Continuity of life
  
• Centralization of management
  
• Free transferability of ownership

1. Satisfying the Four-Factor Test (Pre-1997). In order to avoid structuring an organization which would be deemed to be a corporation for income tax purposes, the LLC must have had no more than two of the four characteristics that define a corporation: (1) limited liability, (2) continuity of life, (3) centralization of management, and (4) free transferability of ownership.
   1. Limited Liability. The members of the LLC certainly desire "limited liability" for the debts and expenses of the LLC. Because this characteristic is a given, the LLC was allowed to have only one of the other three characteristics. In fact, state LLC statutes usually tried to allow the owners (members) to avoid all of the other three characteristics.

   2. Continuity of Life. "Continuity of life" is the continuation of the business entity without regard to the death of the owners. To purposefully violate this characteristic, the duration of the LLC could not be perpetual.

   3. Centralization of Management. A corporation has "centralization of management" because of its management through a board of directors. This corporate characteristic can be avoided by giving all LLC members the right to be involved in the management of the LLC. However, if the owners of an LLC choose to establish "managers," the LLC could still avoid tax status as a corporation by avoiding two of the other three corporate characteristics.

   4. Free Transferability of Ownership. Generally, the owners of a corporation can "freely transfer their ownership" in the corporation by selling their shares of stock. To avoid this corporate characteristic, the LLC can impose transfer restrictions, for example, that a member may not transfer his/her units without the consent of all of the other members.
   
   
2. Federal Taxation for LLCs Formed After January 1, 1997 Under new IRS "check the box" regulations, LLCs consisting of two or more members will be automatically taxed as partnerships unless they affirmatively elect to be taxed as a corporation. Single-owner LLCs will be taxed as a sole proprietorship unless they affirmatively elect to be treated as a corporation. In other words, for federal tax classification purposes, the old four-factor test is no longer relevant. LLCs can enjoy partnership -, or sole proprietorship -, "pass through" taxation of income even though they may be organized to have (a) unlimited life, (b) centralized management, (c) limited liability, and (d) free transferability of ownership.

A corporation is a separate legal entity owned by one or more shareholders, and the shareholders have "limited liability." The shareholders elect directors who have overall responsibility for the management of the corporation. The directors elect officers who carry out the wishes of the directors. Thus, a corporation is more complex than either a sole proprietorship or a partnership. However, some of this complexity can be simplified in many small companies by having the shareholders serve as both directors and officers.

1. Organizational Formalities. These cover such items as articles of incorporation, organizational minutes (or consent), bylaws, stock certificates, federal employer identification number, and minutes and annual reports.

2. Limited Liability. The owners of the corporation (the shareholders) enjoy "limited liability," that is, the shareholders are only liable for the debts and expenses of the corporation up to the amount of their respective investments in the corporation's stock. However, some state laws may impose liability on the shareholders for unpaid wages in small corporations. Additionally, creditors frequently require the majority shareholder(s) to guarantee the debts of the small corporation or co-sign its notes in their individual capacity, or pledge their personal assets as security for the corporation's loans.

3. Income Taxation. The income and expenses of a corporation are reported on a separate tax form (Form 1120). Unlike the other forms of business entities, the corporation then pays its own taxes on its net income, instead of allocating the income to the owners. (However, alternative tax treatment is available if a "Subchapter S" election is made.)

4. Fringe Benefits. Generally, corporations have the most flexibility in deducting the costs of providing fringe benefits to employees, which is especially attractive for employees who are also officers and shareholders.

5. Double Taxation. Shareholders can authorize the payment of dividends to themselves as a means of withdrawing accumulated profits from the corporation. The payment of dividends results in taxable income to the recipient shareholder, even though the corporation already paid tax on that income. This "double taxation" significantly reduces the "after tax" dollars for the owners. However, this double-taxation consequence is easily avoided in closely-held corporations because the shareholders can simply pay themselves greater wages or bonuses (subject to reasonableness) which are deductible by the corporation (taxable to the shareholder) and therefore a means of "distributing" the corporate profits which are taxed only once.

6. Use of the Regular Corporation. Corporations are formed to gain "limited liability," and in some cases, gain an advantage in deducting fringe benefits.

A disadvantage of the "S" corporation is the number of technical tax rules. For example, the following rules (among others) apply:

1. Number of Shareholders. An "S" corporation may not have more than 75 shareholders.

2. One Class of Stock. An "S" corporation may only have one class of stock.

3. Calendar Year-end. Generally, the corporation must use a tax year that ends on December 31 of each year, unless the corporation can show that it has a "peak period" of business that ends other than shortly before December 31.

4. Fringe Benefits. Some types of fringe benefits (for example, health insurance benefits) are not deductible for shareholders who own more than 2% of the corporation.

Most limited liability companies (LLCs) are taxed as a sole proprietorship (if there is one member) or as a partnership (if there are two or more members). This means that the profits and losses of the LLC are taxed directly to the owner(s) rather than taxed at the entity level. Therefore, a distribution of those profits to the owners does not cause additional income to the owners. In other words, because the earnings of the LLC are taxed directly to the owners, the owners can elect to receive those profits out of the LLC without having to declare it as personal income a second time.

Note that the situation is different for a "C" corporation, including an LLC which elects to be taxed as a "C" corporation. "C" corporations make distributions by paying dividends. However, the payment of dividends by a "C" corporation results in "double taxation" because the business income of a "C" corporation is taxed at the corporate level and then when dividends are paid to the owners, those dividends are taxed again as income to the owners and not deductible by the corporation.

Most state laws governing limited liability companies (LLCs) require that the Articles of Organization of the LLC define how long the LLC will exist. In the recent past, most states required that the term be something less than "perpetual," for example, thirty years. This was required because of a complicated set of tax rules that had to be satisfied in order to gain more favorable tax treatment as a partnership rather than as a corporation. Specifically, by choosing a term of years rather than specifying a perpetual existence, the LLC avoided the corporate characteristic of "continuity of life," which helped it avoid being taxed as a corporation. However, after the enactment of Internal Revenue Service "check the box" regulations, which became effective January 1, 1997, most states now permit perpetual duration (while stilll affording the LLC with favorable tax status).

Even if a term of years is chosen, the LLC does not necessarily terminate forever. When the specified term of years is about to expire, all of the remaining members of the LLC can vote to amend the Articles to provide for an additional specified term of years. The vote must be unanimous; therefore, every member has veto power. On the other hand, a decision to continue the LLC beyond its original term as an "at will" company (i.e., for an unspecified additional term) does not usually require the unanimous consent of the members.

An Employer Identification Number (EIN) is a nine-digit number (for example, 12-3456789) assigned to limited liability companies (LLCs) and other entities for federal tax filing and reporting purposes. The LLC should obtain an EIN for several reasons:

1. The bank will request the EIN in setting up a business checking account for the LLC; and

2. The EIN will be needed for filing the LLC income tax forms, as well as other required tax returns.

Assume that the Articles of Organization of Acme, LLC are recorded with the state's Secretary of State. They provide that the LLC will be managed by managers. Assume further that the Operating Agreement, which is not recorded, establishes the offices of President, Vice-President, Secretary and Treasurer. A third party who intends to purchase real estate from the LLC, which is in the manufacturing business, should not accept a deed signed by the President, without more, because:

1. the sale is not in the "ordinary course of business," and therefore there is not even "apparent authority" for the managers to sign the deed -- the members should approve the sale, and

2. there is neither apparent authority nor actual authority "of record" that the officers are authorized to act on behalf of the LLC.

Under new IRS "check the box" regulations, LLCs consisting of two or more members will be automatically taxed as partnerships unless they affirmatively elect to be taxed as a corporation. Single-owner LLCs (where allowed by state law) will be taxed as a sole proprietorship unless they affirmatively elect to be treated as a corporation. In other words, for federal taxation classification purposes, the old four-factor test is no longer relevant. LLCs can enjoy partnership, or sole proprietorship, "pass through" taxation of income even though they may be organized to have:

1. limited liability,

2. unlimited life,

3. centralized management, and

4. free transferability of ownership.

A limited liability company (LLC) is usually restricted in its ability to deduct the cost of benefits provided to the employees. Because most LLCs are taxed as a partnership (if there are two or more owners) or as a sole proprietorship (if there is only one owner), they can only deduct the cost of benefits provided to non-owner employees.

In contrast, if the LLC elects to be taxed as a "C" corporation, it can generally deduct the cost of group health insurance plans, pension plans and limited amounts of life insurance, even for owner/employees, provided that certain tax regulations are followed which discourage plans that primarily benefit highly compensated employees (who are often the officers and/or owners of the business). But there is a trade-off: electing to be taxed as a "C" corporation also results in "double taxation" of the business profits -- once at the corporate level, and again when those profits are distributed as dividends to the owners.

A general partnership is like a sole proprietorship except that it is owned and managed by more than one owner.

1. Organizational Formalities. Generally, organizational formalities are not required by law to form a partnership, but often the partners adopt a partnership agreement that explains how the partnership will be operated and governed.

2. Personal Liability of Partners. Similar to a sole proprietorship, each partner is personally liable for all of the debts and expenses of the business, that is each partner's liability is "unlimited." Further, each partner is liable for the acts of the other partners.

3. Income Taxation. The income and expenses of a partnership must be reported on a separate tax return (Form 1065). The net income of the partnership is then allocated to the partners, and the individual partners report their respective shares of the income on their individual income tax returns.

4. Taxation of Fringe Benefits. A partnership may have more flexibility in deducting the costs of providing fringe benefits to employees than a sole proprietorship, but the costs of such benefits provided for the partners themselves may not be deductible.

5. Use of a General Partnership. The partnership form of business is most often used for small businesses whose owners want to avoid the tax consequences that result from corporate ownership and are willing to accept personal liability. One of the main drawbacks of the general partnership is that the partnership is dissolved or liquidated whenever a general partner ceases to be a partner for any reason, unless the remaining partners agree to continue the business, which consent is often difficult to obtain.

The limited liability company (LLC) is a form of business entity which represents a second attempt (in addition to the "S" corporation) to combine the "limited liability" feature of the "C" corporation with the desirable tax consequences of the partnership. LLCs are a relatively new form of business entity. Although Wyoming enacted the first LLC statute in 1977, other states did not follow suit in significant numbers until the early 1990s. As of this writing, LLC statutes are in effect in all fifty states. The limited liability company has the following characteristics:

1. Limited Liability. Similar to a corporation, LLC statutes provide that the owners ("members") of an LLC have "limited liability" for the debts and expenses of the LLC. Members are only liable up to their investment in the LLC; their personal assets are protected. However, the Articles of Organization should include a specific recitation which limits or eliminates the personal liability of the managers (if any) and the members for the debts of the limited liability company. In addition, the Articles should specify that the managers, if any, will not be liable to the company or its members unless they breach certain types of their duty of care. And finally, the Articles may include provisions obligating the company to indemnify (defend) the managers and officers against being sued personally for taking, or failing to take, certain actions. Without this protection, managers and officers may be hesitant to serve.

   Additional protection for the LLC can be obtained through appropriate liability insurance, although some kinds of liability may be uninsurable.

2. Duration/Term. Most state laws governing limited liability companies (LLCs) require that the Articles of Organization of the LLC define how long the LLC will exist. See Duration/Term of the Limited Liability Company for specific information about these requirements.

3. Management. The LLC can be organized so that all of the LLC members have the right to be involved in the management of the LLC. Alternatively, if the owners of an LLC choose to allow only certain persons to participate in management, the LLC can specify that "managers" rather than the members will have the authority to manage the day-to-day business of the LLC. The owners can still retain the right to vote on all non-routine matters, such as major purchases and sales of assets, admission of new members, and merger or dissolution of the LLC.

4. Transferability of Interests. Most LLC statutes provide that an LLC owner may not transfer his or her units of ownership in the LLC without the consent of the other members. What can be transferred is the member's "distributional interest" which merely entitles the transferee to those distributions that the transferor member would otherwise receive. (In fact, if the member transfers all of his or her distributional interest, that member usually ceases to be a "member" and forfeits his or her ability to participate in voting.) The transferee of a distributional interest may become a member of the LLC if all of the remaining members consent. Until then, the transferee does not become a member, and is not entitled to participate in the management of the LLC's business.

5. Tax Treatment. For LLCs formed after January 1, 1997, the LLC is usually treated by the Internal Revenue Service for tax purposes as a partnership if there are two or more members, or as a sole proprietorship if there is a single member. Alternatively, the LLC can elect to be taxed as a corporation. For most LLCs where there are two or more members, the income and expenses are reported on a partnership tax return (Form 1065). The net income of the "partnership" is then allocated to the owners ("members") on Schedule K-1 forms, and the individual members report their respective shares of the income on their individual income tax returns (Form 1040).

6. Formation. All states now have specific LLC statutes that govern the formation and operation of LLCs. An LLC is formed by filing Articles of Organization (also referred to as a "Certificate of Organization" or "Certificate of Formation," depending on state law) with the Secretary of State. The LLC is also required to adopt an Operating Agreement that describes the rights and obligations of the owners, as well as how the LLC will be operated. In contrast to the recent past, most states now allow LLCs to have a single member.

7. Name. LLC statutes require that certain words such as "Limited Company," "LLC" or "LC" be included in the name of the LLC to show its status as an LLC.

The LLC is a form of business entity which represents a second attempt (in addition to the "S" corporation) to combine the "limited liability" feature of the corporation with the tax advantages of the partnership. LLCs are a relatively new form of business entity. Wyoming enacted the first LLC statute in 1977 and, as of this writing, LLC statutes are in effect in all fifty states.

1. Organizational Formalities. The formation of an LLC is similar to the formation of a business corporation � by filing Articles of Organization with the Secretary of State. The Articles must include basic information regarding (1) the name and address of the LLC and its registered agent, and (2) its period of duration, for example, 10 to 35 years, although most states now permit perpetual duration.

   The Articles can also include provisions regarding (A) the management of the LLC by all members (the owners) or certain persons (who can, but need not be members), known as "managers," a term similar to corporate directors, (B) limited liability of its members and managers, and (C) whether less than a unanimous vote of the members is required to dissolve, sell or merge the LLC or amend its governing documents (Articles of Organization and Operating Agreement). Some states still have statutes requiring an LLC to have two or more persons as members at the time that it is formed, but most states now allow single-member LLCs.

2. Operating Agreement. The LLC must also adopt an Operating Agreement that describes the rights and obligations of the members and how the LLC will be operated. The Operating Agreement is similar to a partnership agreement and somewhat similar to corporate bylaws.

3. Federal Tax Employer Identification Number. A federal tax Employer Identification Number should be obtained, as well as possible permits and licenses, depending upon the activities of the LLC.

4. Limited Liability. Similar to a corporation, the owners ("members") of an LLC have "limited liability."

5. Income Taxation. The LLC is usually structured to avoid corporate taxation. For LLCs formed prior to January 1, 1997, it was necessary to carefully structure the LLC to avoid the characterization by the Internal Revenue Service that the LLC was so similar to a corporation that it should be taxed as a corporation. These objectives may still be important for purposes of state income taxation. However, effective January 1, 1997, the Internal Revenue Service adopted new regulations which, for federal income tax purposes at least, abandons the old "four-factor" test and allows most LLCs to be taxed like a partnership or a Subchapter S Corporation. See Satisfying the Four-Factor Test (Pre-1997) and Federal Taxation for LLCs Formed After January 1, 1997

6. Use of LLCs. The LLC form of business entity is used primarily by small businesses that want:
   1. the limited liability protection of a corporation;

   2. the flexibility of organization and tax benefits of a partnership;

   3. the ability of the members to take part in the management of the business, unlike the prohibition that applies to limited partners in a limited partnership and the cumbersome three-tiered management structure of shareholders, directors and officers of a corporation;

   4. the protection to members afforded by many state statutes that disallow the transfer of any member's management rights in the LLC (versus "financial rights" which can often be transferred without restriction) without the consent of the non-transferring members; and

   5. freedom from the "S" corporation eligibility requirements. Although there are a few uncertainties involved with the formation of an LLC because it is a relatively new form of entity, there is an increasing trend toward the use of LLCs for small businesses, particularly service-oriented businesses.

There are several types of business entities which can be formed. It is recommended that you read Types of Business Entities before going forward with the Limited Liability Company Worksheet. If you determine that a limited liability company is the proper type of entity for your needs, you can use this LLC Worksheet to organize the information a lawyer or other advisor will need to prepare the documents necessary to form the limited liability company ("LLC").

Most likely, an LLC is formed under the laws of the state in which the business operations of the LLC will be located. Otherwise, the LLC will need to qualify as a "foreign" LLC in the state where it will operate, and it may be necessary to pay annual fees and license taxes in both states.

An LLC is formed by filing "Articles of Organization" (also referred to as a "Certificate of Organization" or "Certificate of Formation," depending on state law) with the state's Secretary of State. The Articles must contain a minimum set of required information; other information is optional. A filing fee must be paid when the Articles are filed. In conjunction with the filing of the Articles, it is necessary to also prepare an Operating Agreement. This document is similar to a partnership agreement, because it defines how the LLC will be operated and managed, and how the profits and losses will be distributed.

The formation of an LLC may also be subject to federal and/or state securities laws, especially if all of the owners ("members") will not be actively managing the LLC. Consult an attorney or other advisor for further information.

A further variation of the general partnership is the LLP. The specific provisions of the LLP depend upon state law, but generally a partner in an LLP is not liable for the obligations of the partnership arising from the negligence, wrongful acts, or misconduct of another partner. However, each partner remains liable for the general contractual and commercial obligations of the partnership and for his or her own acts. The LLP entity is popular primarily with multi-state accounting firms.

The limited partnership is a variation of the general partnership, designed to cure the "unlimited liability" disadvantage. A limited partnership has one or more of both "general" and "limited" partners. The general partner is responsible for the management of the partnership, receives a share of the partnership profits and losses, and is personally liable for the debts. The limited partners share in the profits and losses but are not permitted to have any management responsibilities. In return, their liability is limited to their investment in the partnership.

The limited partnership form of business is most often used for specific projects, for which a developer (the general partner with technical and management expertise) wishes to attract investors (limited partners) who do not want the risk of personal liability and are comfortable in allowing someone else to manage the project.

An LLC is owned by its "members." The Articles of Organization and/or the Operating Agreement may provide that the power to bind the LLC is vested either in its members or in its managers. Managers do not have to be members. In a manager-managed company, the members have no involvement in the management of the company's business (unless they are also managers). If no managers are established by the Articles or Operating Agreement, all authority remains with the members.

The managers (of an LLC run by managers) or members (of an LLC run by its members), can appoint officers -- a President, one or more Vice-Presidents, a Secretary and a Treasurer -- to carry out the day-to-day tasks and to implement the policies established by the members or managers.

The limited liability company name must include an indication that the entity is a limited liability company so that parties who deal with the company are aware of its status. Therefore, the name must include one of the following words or an abbreviation of the word:

• Limited Company (L.C. or LC or Ltd. Co.)
  
• Limited Liability Company (L.L.C. or LLC)

• Corporation (Corp.)
  
• Incorporated (Inc.)
  
• Limited Partnership (L.P.)

Before proceeding with the organizational steps, it is advisable to contact the applicable Secretary of State to verify that the chosen name for the new company is available.

In contrast to the recent past, most states now allow LLCs to have a single owner ("member"). There is no maximum number.

The Articles of Organization typically define the basic structure of the limited liability company ("LLC"). The "Operating Agreement" is often used to further define this structure, and can contain any provisions not inconsistent with state law or the Articles, relating to the business of the LLC, the conduct of its affairs, and the rights and powers of the members, including how the profits and losses are allocated among the members.

A typical Operating Agreement will include the following topics, unless such topics have already been addressed in the Articles:

• Fix the term of the LLC to be either perpetual or for a term of years. If the latter is selected, then after the term expires, the LLC will be dissolved unless the remaining members vote to extend the term.

• Define whether the LLC will be managed by the entire group of its members, or, conversely, by designated "managers."

• Define how the profits and losses of the LLC will be allocated to the members, usually in proportion to their ownership of units.

• Specify the voting requirements for the members meetings.

• Specify whether the members can take action by written consent without a meeting.

• Establish the officer positions, describe their duties, specify whether an individual may hold multiple officer positions, and prescribe the method of appointing officers and filling vacancies.

• Indemnify (agree to defend) the members (and managers) against personal liability.

• Restrict the transfer of units to outside parties and specify how new members may be admitted.

• Specify how the LLC will be dissolved and how the assets will then be distributed.

Organizational formalities for a corporation include articles of incorporation, organizational minutes (or consent), bylaws, stock certificates, federal tax employer identification number, and minutes and annual reports.

1. Articles of Incorporation. The corporation is formed by filing Articles of Incorporation with the Secretary of State. The Articles must include basic information regarding the names and addresses of the corporation, the registered agent, and the incorporator, as well as the number of authorized shares of stock. In addition, the Articles can include provisions regarding limited liability of the directors, preemptive stock rights, staggered directors' terms, and any unusual shareholder meeting requirements.

2. Organizational Minutes (or Consent). A corporation is also required to hold an organizational meeting to elect initial directors (unless already named in the Articles of Incorporation), elect officers, adopt bylaws and take care of other organizational matters. Corporate minutes are prepared in order to document the decisions reached and actions taken. Instead of an actual meeting, these organizational activities can be handled by a written "organizational consent" signed by all of the incorporator(s) or the initial directors, unless such a method is prohibited in the Articles.

3. Bylaws. In addition to Articles of Incorporation, a corporation must have a set of Bylaws which define how the business and affairs of the corporation will be managed and regulated. Typically, a set of Bylaws includes provisions regarding shareholder meetings and voting, and the duties, qualification, election, terms and meetings of the directors. The bylaws (or the articles) may also include provisions regarding stock transfer restrictions, the execution of written instruments, higher-than-majority quorum requirements for director meetings, and indemnification of directors.

4. Stock Certificates. A corporation may choose to issue stock certificates as evidence of the ownership by the shareholders of their respective interests in the corporation. However, physical certificates are not always required.

5. Federal Tax Employer Identification Number (EIN). An EIN must be obtained for the corporation using Internal Revenue Service tax form "SS-4." Other forms, applications and licenses may be required, depending on the activities of the corporation. For example, there may be a need to register as a contractor, or the need to obtain a sales tax permit.

6. Minutes/Annual Reports. After formation, the corporation must observe certain formalities in order to preserve its separate legal status. Minutes or other records of shareholder and director action must be prepared at least annually. Additionally, annual reports generally must be filed with the Secretary of State.

Professional corporations are a variation of the basic corporate form. They are used by professionals -- persons who are required to obtain a license from the state in order to practice their profession, for example, physicians and lawyers.

A shareholder in a professional corporation must be a licensed professional in the same profession, and continues to be personally liable for his or her own professional conduct. But the professionals do receive liability protection with respect to the professional conduct of the other shareholders.

Every limited liability company ("LLC") registered or doing business in a state must have both a registered office and a registered agent located in that state. The registered agent is the official contact for the LLC and will accept notices and correspondence from the Secretary of State, a member, or any entity attempting to sue the LLC.

The agent may be either a resident individual or an entity qualified to do business in the state. In fact, an LLC can act as its own registered agent if it is qualified to do business in the state. However, most LLCs who have their principal office in a state other than where they organize utilize a service company who acts as registered agent for a large number of companies for a fee.

The registered office must provide a street address and not merely a post office address.

The identity of the agent and/or the address of the registered office can be changed by notification to the Secretary of State.

In order to avoid structuring an organization which would be deemed to be a corporation for income tax purposes, the LLC must have had no more than two of the four characteristics that define a corporation: (1) limited liability, (2) continuity of life, (3) centralization of management, and (4) free transferability of ownership.

1. Limited Liability. The members of the LLC certainly desire "limited liability" for the debts and expenses of the LLC. Because this characteristic is a given, the LLC was allowed to have only one of the other three characteristics. In fact, state LLC statutes usually tried to allow the owners (members) to avoid all of the other three characteristics.

2. Continuity of Life. "Continuity of life" is the continuation of the business entity without regard to the death of the owners. To purposefully violate this characteristic, the duration of the LLC could not be perpetual.

3. Centralization of Management. A corporation has "centralization of management" because of its management through a board of directors. This corporate characteristic can be avoided by giving all LLC members the right to be involved in the management of the LLC. However, if the owners of an LLC choose to establish "managers," the LLC could still avoid tax status as a corporation by avoiding two of the other three corporate characteristics.

4. Free Transferability of Ownership. Generally, the owners of a corporation can "freely transfer their ownership" in the corporation by selling their shares of stock. To avoid this corporate characteristic, the LLC can impose transfer restrictions, for example, that a member may not transfer his/her shares without the consent of all of the other members.

1. The Limited Liability Company Worksheet is not a legal document and does not require any signatures, witnesses or notarization.

2. The Worksheet is an educational tool, and can be used to organize the information that may be needed by a lawyer, an accountant or other professional advisors to set up a limited liability company.

A sole proprietorship is an unincorporated business owned and managed entirely by the "proprietor," except to the extent that the proprietor may delegate management responsibilities to an employee. It is the simplest form of business. However, simplicity may be the only advantage of the sole proprietorship.

1. Organizational Formalities. There are no organizational formalities required and generally no other agreements necessary. However, if the business will have employees, a federal tax Employer Identification Number will be required. A sales tax permit and/or licenses may be required.

2. Liability of Owner. The owner is personally liable for all of the debts and expenses of the business, that is, the owner's liability is "unlimited." If the business is unable to pay its obligations, the non-business assets of the owner will be at risk unless protected by an exemption (for example, the homestead exemption for the owner's personal residence). Some protection can be obtained through liability insurance.

3. Taxation. The income and expenses of the sole proprietorship are reported as part of the owner's individual income tax return. There is no extra tax return to be prepared each year. Every other form of business entity requires a separate tax return for the business (except an LLC taxed as a sole proprietorship).

4. Taxation of Fringe Benefits. A sole proprietorship generally has less flexibility to deduct the costs of fringe benefits, which means fewer after-tax dollars.

5. Use of the Sole Proprietorship. The sole proprietorship form of business is most often used for small, low-risk businesses that have only a few employees and no need for more than one owner.

Both business corporations and professional corporations can make a special "S" corporate election that alters how the income of the business is taxed. After forming a corporation, the shareholders elect "S" status for tax purposes under Subchapter S of the Internal Revenue Code by filing Form 2553 with the Internal Revenue Service on or before two months and 15 days after the beginning of the taxable year in which it is to be effective.

The income and expenses of an "S" corporation are reported on a separate tax return (Form 1120S), but like a partnership, the net income of the "S" corporation is then allocated to the shareholders who report their respective shares of the income on their individual income tax returns. Therefore, the "S" corporation combines the "limited liability" feature of the regular corporation with the tax advantages of the partnership.

A disadvantage of the "S" corporation is the number of technical tax rules. For examples, see Disadvantages of the S Corporation.

The "S" corporation form of business is most often used by service-oriented businesses who want the "limited liability" feature of the corporation, but do not want the tax consequences of a "C" (regular) corporation. These owners want to distribute corporate profits to themselves because significant amounts of corporate income are not needed for the capital needs of the corporation, such as inventory and equipment. These owners do not want the "double taxation" problem that occurs when dividends are paid out of a regular corporation.

Some states require that the Articles of Organization identify which member of the limited liability company will be the "tax matters member." Furthermore, it may be necessary to provide this information to the Internal Revenue Service as a contact person for tax matters.

A limited liability company (LLC) must usually adopt a calendar year-end, with some limited exceptions.

Note that a "C" corporation is allowed to select a fiscal year for its tax year, i.e., it is not required to use a December 31 year-end. The selection of a fiscal year which does not end on December 31 may be important if the business activities are seasonal and the end of a normal business cycle occurs at a time other than December 31.

The income and expenses of a single-member limited liability company (LLC) are reported on Schedule C of the owner's individual income tax return (Form 1040). The income and expenses of a multiple-member LLC are reported on a separate business return (Form 1065); however, the net income of the business is then allocated to the individual owners on Schedule K-1 forms, and the individual owners report their respective shares of the income on their individual income tax returns (Form 1040).

Alternatively, if the LLC elects to be taxed as a corporation, it will report its income and expenses on Form 1120, and pay taxes on the income at corporate rates. Dividends are not deductible by the LLC and constitute taxable income to the owners, so income, if distributed, is taxed twice.

Thus, the net business income of most LLCs (unless they elect to be taxed as a corporation) is taxed at individual rates. Corporate rates are generally lower if net business income does not exceed $75,000. If net business income is expected to be less than $75,000, and the owners expect to leave the profits in the LLC instead of distributing the profits, the corporation tax election may be preferable. However, corporate tax treatment is usually avoided. This tax analysis is greatly simplified, and is not a substitute for the advice of a tax expert.

Most limited liability company ("LLC") statutes provide that an LLC owner may not transfer his or her units of ownership in the LLC without the consent of the other members. What can be transferred is the member's "distributional interest" which merely entitles the transferee to those distributions that the transferor member would otherwise receive. (In fact, if the member transfers all of his or her distributional interest, that member usually ceases to be a "member" and forfeits his or her ability to participate in voting.) The transferee of a distributional interest may become a member of the LLC if all of the remaining members consent. Until then, the transferee does not become a member, and is not entitled to participate in the management of the LLC's business.

There are four basic types of business entities: the sole proprietorship, the partnership, the corporation and the limited liability company (the "LLC"). See the appropriate topic below for more information about each type.

In a member-managed limited liability company ("LLC"), unless otherwise provided, each member has equal rights in the management of the LLC's business. This "per capita" ("one-per-person") allocation of voting rights is usually modified in the Operating Agreement to provide, for example, that voting rights are based on capital contributions rather than equally among all members.

Even if a majority vote is allowed is for most official actions, most Operating Agreements provide that a unanimous vote of the members is required in order to authorize certain unusual acts:

• amendment of the Operating Agreement
  
• amendment to the Articles of Organization
  
• the admission of a new member
  
• the authority to sell, merge or dissolve the LLC
  
• the sale of substantially all of the LLC's property