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Answers to Frequently Asked Questions About the California Limited Liability Company (LLC)

 
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Answers to Frequently Asked Questions About the California Limited Liability Company (LLC)

Prepared By: Melissa C. Marsh, Los Angeles Business And LLC Attorney
Written: March 2009
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Q. What is a California Limited Liability Company (LLC)?
A.
A California limited liability company (LLC), sometimes called a limited liability corporation, is a hybrid of the Partnership and Corporation. The LLC, if properly formed and maintained, offers its members personal limited liability protection (like a corporation) and pass-through tax treatment (like a partnership). California offers three types of LLCs: (1) a single member LLC; (2) a multi-member member managed LLC; and (3) a multi-member manager managed LLC. The LLC is created when proper Articles of Organization are filed with the Secretary of State, and all the organizational fees are paid. California imposes additional post-creation requirements, including the filing of a Statement of Information.

Q. Can anyone form a California LLC?
A.
No.
Pursuant to California law (California Corporations Code §17002), a limited liability company may engage in any lawful business except banking services, insurance services, and trust company business. In addition, a California LLC is prohibited from providing professional services that must be rendered pursuant to a license, or certification by the Business & Professions Code, or the Chiropractic Act. California Corporations Code Section 17375 Certain professionals, such as: doctors, dentists, lawyers, accountants, architects, real estate brokers, general contractors, chiropractors, etc., are precluded from conducting business through a California LLC.

Q. Can a nonresident alien own a percentage of an LLC?
A.
Yes
, unlike an California S-corporation which prohibits a non-resident alien shareholder, a California LLC can have a non-resident alien member. However, if a California LLC has one or more members who are nonresidents of California, the LLC must file with the California Franchise Tax Board (FTB) a list of all such members, their taxpayer identification number, and each member's consent to the jurisdiction of California on FTB on Form 3832 and Form 568.

Q. Do I need an attorney to form an LLC?
A.
No
, an attorney is not a legal requirement, but online formation services and document providers will typically only provide you with fill-in-the-blank forms (form Operating Agreement, form Organization Minutes, and form Membership Interest documents), which unfortunately eliminates the main benefit of the LLC - the ability to customize the relationship of the members. These online services also often leave the members to operate the LLC with little or no instruction which in a majority of cases causes the LLC members to lose their personal limited liability protection, thus exposing each of the members to potential personal liability for the LLC's debts and obligations. I can say this a 100 times, "do it right or don't do it all." I can also say, "an ounce of prevention is worth a pound of cure." I can even ask, "would you go to a nurse, instead of a doctor, for cardiac surgery." But the reality is most people will not see a lawyer until they are forced to hire a litigation attorney, or bankruptcy attorney, who informs them that they could have protected their personal assets, but didn't.

Most attorneys, especially civil litigators, have a lot to gain from owners of companies (especially LLCs and Corporations) who fail to form and operate their business with the required formalities because instead of spending a few hundred dollars a year with a business attorney or corporate attorney to dot the i's and cross the Ts, now the individual is going to spend $10,000 to $50,000 to defend a lawsuit, and still face the real probability of not only having to file a company bankruptcy, but a personal bankruptcy as well.

Rich people can afford to make a mistake. But the middle class cannot. One mistake and typically they are out of business.

When I as a corporate business attorney for 10+ years form a California limited liability company, I provide not only custom Articles of Organization, but also a custom LLC Operating Agreement and a 10+ page memorandum on how to properly maintain your California LLC. The reason for the custom documents is to provide, amongst a multitude of other things, (1) detailed instructions on how to run and operate the LLC; (2) qualifications as to who can be a manager of the LLC; (3) restrictions on which members/managers can bind the limited liability company; (4) provisions to reduce the likelihood of disputes among the members; and (5) a mechanism to resolve disputes or a deadlock among the members without costly litigation (at least where possible).

Q. What are some the advantages and disadvantages to forming a California LLC?
A.
A California limited liability company (LLC) is probably the most flexible entity choice in terms of management and structuring economic sharing arrangements among the members. A California LLC also offers the following advantages:

  • Personal limited liability protection for all members, such that unless a member personally guarantees a debt or obligation, or fails to form or maintain the LLC properly, the member may not be held personally liable for the LLC's debts and obligations.
  • Pass-through tax treatment to eliminate the potential for double taxation like a partnership and a S-Corporation.
  • No restrictions on permitted members, such that non-resident aliens and corporations can be members of a California limited liability company (unlike an S–Corporation).
  • Less burdensome local and state reporting requirements than those required by an S-Corporation.
  • Less upkeep and maintenance than a typical corporation.
  • Much greater flexibility than an S-Corporation when it comes to management; a California LLC can be structured to be managed by either its members (member-managed LLC) or an elected centralized management team (a manager-managed LLC) and the Operating Agreement can be drafted in such as manner that the members right to remove managers is limited.
  • Much greater flexibility than an S–Corporation when it comes to income and loss distribution; for example, where one owner agrees to contribute all of the cash needed for the business, and another owner agrees to contribute his time or services by working full-time for the LLC, the parties might want to structure a preferred cash-on-cash return to the money partner. This can be easily done with an LLC, but would be very difficult to accomplish with an S-Corporation.
  • Much greater flexibility when it comes to structuring the voting and profit participation rights of the LLC members. For example if a corporation is owned by two shareholders (one who owns 60% of the shares and the other 40% of the shares), the two shareholders would still have equal voting rights on the board of directors even though one shareholder is entitled to 60% of the profit and the other 40% of the profit. With a California LLC, the two owners can provide for a 60-40 profit split and voting split, which is very difficult to do with an S-Corporation.
  • And, for the sole proprietor seeking to form a single member LLC, the ultimate benefit is that the owner of the LLC will not be required to file an additional tax return - just a Schedule C while simultaneously benefiting from the personal limited liability protection afforded to the member of an LLC.

Unfortunately many of the advantages offered by the California LLC are lost when an LLC is formed online, or by an inexperienced practitioner who only provides Basic form Articles of Organization and a basic LLC Operating Agreement. Nevertheless, despite the many advantages, the LLC does suffer from some mighty drawbacks. (discussed below)

Q. What are the main disadvantages to operating a business through a California limited liability company (LLC)
A.
Despite the many advantages outlined in the above question-answer, a California limited liability does suffer from some big drawbacks. The first disadvantage to a California LLC is the fact that many accountants still have difficulty with the laws surrounding the LLC (e.g. a single member LLC does not need to file any special return, just a Schedule C). The second drawback to a California LLC is the additional tax imposed by the California Franchise Tax Board. A California LLC is not only required to pay the minimum $800 franchise tax imposed on California corporations, but also a tax on its gross revenues exceeding $250,000. The third drawback, if the second weren't enough, to a California LLC is the fact that many of the advantages afforded by a California LLC can only be realized in a customized LLC Operating Agreement (25 to 70 pages) which typically takes twice the time to prepare than an S-Corporation, and generally costs twice as much. The fourth drawback to the California LLC is the fact that certain tax deductions afforded to a California corporation is not available to a California LLC.

While the LLC may be more difficult and costly to properly form than a corporation because of the need for a detailed Operating Agreement, it is much more flexible in terms of structure and management, less burdensome in terms of local and state reporting requirements, and requires less upkeep and maintenance than a California S corporation. Thus while more difficult, and in turn more expensive to have properly formed, in the long run it is probably less costly to maintain IF your businesses gross revenues will not exceed $500,000 a year.

Q. What Is The Difference Between a Member-Managed LLC and a Manager-Managed LLC?
A.
When all of the members directly manage the limited liability company ("LLC"), it is a member-managed LLC. By contrast, when the members elect or appoint some of the members to be managers to manage the LLC, it is a manager-managed LLC. Your Articles of Organization, or Operating Agreement, should specify which management method best suits your needs. My firm typically leans toward a member managed LLC because of the additional requirements imposed on manager managed LLCs in the State of California. That said, about 40% of the time I form a manager-managed LLC because it will better suit the needs of those clients.

Q. What paperwork must be completed to form and organize a California LLC?
A.
Please see, Step By Step Guide on How To Form A California Limited Liability Company (LLC).

Q. In which state should I form my LLC?
A.
You should probably form a LLC in your home state (assuming that is where you will be conducting your business from), just as you should probably incorporate in your home state. If you file your Articles of Organization in another state to save fees or to take advantage of a different state's particular laws, then you will also have to register (qualify as a foreign LLC) in the state where the actual business activity is conducted to preserve your limited liability protection. This in effect will create double fees, the requirement to file two sets of state tax forms, and often will subject the LLC to the laws of your home state anyway. California, for example, will impose its laws on any LLC, regardless of where it is organized, that operates in California.

There is one caveat. If you are forming a real estate holding LLC then you should form the LLC wherever the property to be owned by the LLC is located.

Q. What should I name my LLC?
A.
You should choose the name of your LLC very carefully. The name you select should portray the image you want for your new company, and legally the name must: (1) not be deceptively similar to any existing LLC or corporation in your state and (2) must end in Limited Liability Company, LLC, L.L.C., or Ltd. Co.

If you plan on using your company trade name as a trademark or service mark, you should also ensure that the name you select is available for such use within your state, if that is the only intended market, and federally if you plan to offer your products or services across state lines. You don't want to select a name that you will later be asked to change because it is infringing a registered trademark belonging to a third party.

If, however, you are forming a real estate holding LLC, we suggest you name the LLC in part based on the address of the property that will be placed in the LLC.

Q. Is A California LLC required to hold meetings of its members or managers, like corporations?
A.
No,
but to maintain your personal limited liability protection, to prevent the imposition of the alter-ego theory, and to limit disputes between and among the members we strongly suggest meetings be held at least annually.

Q. Is an LLC required to maintain certain documents at its principal place of business?
A.
YES.
Pursuant to California Corporation's Code § 17058, a California LLC is required to maintain the following documents at its principal place of business:

  1. A copy of the Articles of Organization, and all amendments.
  2. A copy of the LLC's Operating Agreement, and any amendments.
  3. An alphabetical list of the full name and last known home address of each member of the LLC and that member's contribution and the share in profits and losses.
  4. If the LLC is a manager-managed LLC, a current list of the full name and business or residence address of each manager.
  5. A copy of the completed SS-4 Form used to acquire a taxpayer identification number must be kept for 5 years.
  6. A copy of the LLC's financial statements must be kept for the past 6 years.
  7. A copy of the LLC's federal, state, and local income tax returns and reports, must be kept for the past six years.
  8. The LLC's minutes, or written consents, as they relate to the internal affairs of the LLC must be kept for the past four fiscal years.
  9. If the LLC owns, or hold's title to any real estate, a true copy of business records relevant to the amount, cost, and value of all property that it owns, possesses, or controls.

Q. Who votes in an LLC?
A.
Typically all of the members. However, remember that with a California LLC, unlike a corporation, the members voting interests and profit distribution can be structured in any way the member's desire.

Q. How is an LLC Managed?
A.
An LLC may be managed by all of its members or by selected managers. Again, one of the greatest advantages to the LLC is the flexibility it affords. If the LLC is to be managed by its members, it operates much like a partnership. Each member has an equal say in the decision making process of the company. By contrast, if the LLC is to be managed by managers elected by the members, the managers will act in a capacity similar to a corporation's board of directors. These managers are in charge of the affairs of the LLC. Management by all the members (member-managed LLC) is the normal default, but sometimes it is better to have a manager-managed LLC.

Q. How are new members admitted to the LLC?
A.
The procedure for admitting new members should be established in the Operating Agreement. Since the Operating Agreement can be formed or structured in any way the LLC members desired, it should be reviewed to determine the appropriate procedure.

Q. Can I sell my member interest in an LLC?
A.
By default, in California 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 a majority voting interest of the members (excluding the person acquiring the membership interest). However the Articles of Organization, and the Operating Agreement, can restrict the sale of member shares in almost any manner (e.g., only to predefined transferees, only after the LLC has refused to purchase the shares, etc...). Your Operating Agreement should therefore be carefully reviewed, preferably by an attorney, to determine if and how your membership interest can be transferred or sold.

Q. How can I dissolve, or close down, a California LLC?
A.
To close down, or dissolve a California limited liability company, the members must stop engaging in any and all business, file a final tax return with the Franchise Tax Board, and file a notice of cancellation and dissolution with the Secretary of State within 12 months of filing the final tax return. For more details, please see How To Dissolve a California LLC.

If you would like to retain the services of Los Angeles California business lawyer, Melissa C. Marsh, to form and/or properly organize a California corporation or California LLC, please call 818-849-5206 or Send us an Email.


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California business lawyer, Melissa C. Marsh, is based in Sherman Oaks and West Hollywood, and serves individuals and businesses throughout Los Angeles County, including: West Hollywood, Miracle Mile, Beverly Hills, Century City, Santa Monica, Burbank, North Hollywood, Valley Village, Toluca Lake, Studio City, Sherman Oaks, Van Nuys, Encino, and Woodland Hills.

© 2009 Melissa C. Marsh. All Rights Reserved.

 
 

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Disclaimer: The information presented on this web site was prepared by Melissa C. Marsh for general informational purposes only and does not constitute legal advice. The information provided in my articles and alerts should not be relied upon, or used as a substitute for professional legal advice from an attorney you retain to advise or represent you. Your use of this Internet site does not create an attorney- client relationship. Transmission of this article is not intended to create, and receipt of it does not constitute, an attorney-client relationship. All uses of the contents of this site, other than personal uses, are prohibited. You may print or email a copy of any information posted on this web site for your own personal, non-commercial, use, but you may not publish any of the articles or posts on this web site without the Express Written Permission of Melissa C. Marsh.


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Located in Los Angeles, California, the Law Office of Melissa C. Marsh handles business law and corporation law matters as a lawyer for clients throughout Los Angeles including Burbank, Sherman Oaks, Studio City, Valley Village, North Hollywood, Woodland Hills, Hollywood, West LA as well as Riverside County, San Fernando, Ventura County, and Santa Clarita. Attorney Melissa C. Marsh has considerable experience handling business matters both nationally and internationally. We routinely assist our clients with incorporation, forming a California corporation, forming a California llc, partnership, annual minutes, shareholder meetings, director meetings, getting a taxpayer ID number (EIN), buying a business, selling a business, commercial lease review, employee disputes, independent contractors, construction, and personal matters such as preparing a will, living trust, power of attorney, health care directive, and more.