Limited Liability
Overview of Limited Liability Company Requirements

Limited liability companies (LLCs) are a hybrid (mixture) of corporations and partnerships. LLC law has combined the best aspects of corporations and partnerships. The three major advantages to LLCs are:

  1. LiLimited liability for owners;
  2. Limited double taxation;
  3. Flexibility, with fewer legal formalities.

Before we begin the forms, here is basic information about how LLCs work, LLC restrictions and taxes.

Who and what makes up a limited liability company

Members: Owners of the company. This kit assumes that all members are active participants in the business and will have equal rights and privileges. If you have non-active participants or want certain members to have special privileges or priorities, work with an experienced attorney to customize an Operating Agreement to fit your needs.

Managers (optional): If the members choose, the day-to-day operations can be run by one or more managers. In these documents, we have assumed that the members will manage the business, not outside managers.


Anyone who works in the day-to-day operations of the LLC, under the control or supervision of the members (or managers, if applicable). Generally, members are not employees, even if they are involved in day-to-day operations. They are owners. However, there are exceptions. If you have a member whose work with the LLC is significantly greater than the other members, it is possible to treat him as an employee and pay a salary. Do not do this unless all the members have approved and you have consulted a tax professional.

Articles of Organization: The business' charter, which is filed with your Secretary of State. It is a standard form which basically states that the company is in business as an LLC, lists the contact person for any legal actions, and states whether the business will be conducted by managers or by members.

Operating Agreement:: Operating guidelines for members and managers. State law requires an Operating Agreement, which may be verbal or written. This kit has a sample written agreement for a simple LLC.

Things to know about LLCs

Limited legal and financial liability for members

Members are granted limited liability, much like corporate shareholders. That means that creditors only have a claim on the business' assets to repay debts - not the member's personal assets.

Warning: Limited liability is not absolute. Just like corporate shareholders, members can lose the protection of limited liability if they:

  • Fail to pay taxes (including sales tax);
  • Are involved in "prohibited distributions" (distributing money or assets to members in a way that would make the LLC insolvent or bankrupt);
  • Do not follow the Operating Agreement;
  • Are involved in illegal activities;
  • Sign "personal guarantees" to creditors, giving a creditor a claim on a member's personal assets if the LLC cannot repay the debt;
  • Commingle their personal assets and affairs with the LLC's.

Credit guarantees

Because LLCs provide limited liability, companies may be reluctant to grant credit to them. They often ask that a primary member "guarantee" payment. This means that if the company's assets cannot repay the debt, the member agrees to use his personal assets to repay it.

Even if you have to guarantee a loan, having LLC status is still beneficial because it will protect your personal assets from being used to pay for any non-guaranteed debts or for any legal claims. In addition, using an LLC form of ownership prevents you from being held personally (and potentially completely) responsible for your partner's actions, which is the major drawback from forming a partnership.

LLC formalities

The IRS does not have an LLC tax status. When you file your SS-4 form, you will most likely choose to file federal forms as a partnership. LLC law has been developed so that LLCs can avoid corporate (double) taxation, if certain requirements are met. These requirements are described below. The information and Operating Agreement are designed so that your LLC meets these requirements.

To remain an LLC and avoid being taxed as a corporation:

Your business must LACK two of the following four "corporate" characteristics:

Characteristic What it really means

1 Continuous life for the business The business will continue forever even if an owner dies or leaves.

2 Free transferability of interest Owners can sell their interest to anyone at any time.

3 Centralized management One person or a team of people manages the business on behalf of a group of owners.

4 Limited liability Business debts can only be paid from business assets, not the owner's personal assets.

LLCs must choose not to do two of these four characteristics. Since limited liability protection is critical, that means that the LLC must have two of the following:

  • An end date
  • Limited ability to transfer shares
  • No centralized management.

This is why the Operating Agreement in this kit contains:

  • An end date, which can be extended by a vote of all members.
  • If a member dies or withdraws, all the members must agree to continue the LLC.
  • If a member sells his interest, all the other members must vote to allow the purchaser to become a member.
  • The LLC will be managed by members only.

Logistical requirements

All LLCs must:

  • Have one or more members.
  • Designate one person (or corporation registered in your State) to be an "Agent for Service" who will accept any legal documents pertaining to the LLC or its business.
  • Have an office in your State which maintains the following books and records:
    • A current list of members with:
      • Their full name
      • Last known business or residence address
      • Their capital contributions
      • Capital account balance
      • Membership interest
    • Copies of the Articles of Organization and amendments (if any)
    • Copies of the LLC's federal, state and local income tax or information returns and reports for the past six years;
    • A copy of the Operating Agreement and amendments, if any.
    • Copies of the financial statements, if any, for the past six years.
    • The LLC's books and records for the current and past four fiscal years.

Can a husband and wife form an LLC?


LLCs cannot operate these businesses

  • LLC law does not allow LLCs to operate as:
  • Banks
  • Insurance companies
  • Trust companies
  • Professions requiring a license under the Business and Professions Code. See Professional Licensesfor a list.

The state does allow certain professions to form limited liability partnerships (LLPs). Contact your licensing board for complete information.

LLCs: take advantage of their flexibility

With LLCs you can have different member classes or members with different rights. As an example, your founding members can have voting rights, a percentage of profits and special perks. Later, you can add members with different (or no) voting rights or perks or profit share. You can give ownership options to employees for profits with no management or voting rights. You can also give minimum guarantees to certain members, delay distributions to others, or allocate tax losses in greater proportion to members who need tax write-offs.

If you want to take advantage of this flexibility, it is critical that you work with an experienced tax advisor, because the IRS does have certain restrictions that could significantly affect the taxation of the different classes of members. The Operating Agreement has only one class of members. You can amend it at any time with an attorney's assistance.

Revenue versus profit

Hopefully your business will have lots of sales...however, don't make the mistake of believing that your sales revenue is available for hefty personal salaries or business expansion. Payroll must be paid first. Then you will have to pay for your cost of goods and your operating overhead. About 50% of the amount remaining must be paid in taxes (28% federal; 1-6.9% state; 15.3% self-employment tax). The remaining is available for your after-tax salary and business expansion.