Limited Liability Company in California
A limited liability company (LLC) is a business entity that is essentially a hybrid of a corporation and partnership. An LLC is an entity having two or more members that is organized under the Beverly-Killea Limited Liability Company Act. The LLC form offers great flexibility: the Act is designed to assist the formation and operation of small, closely-held or operated business arrangements, but permits LLC structures that are attractive to larger, more complex business ventures. Areas in which the LLC structure are likely to be particularly useful include real estate, joint ventures (especially joint ventures with foreign partners and between corporations), high technology and venture capital, petroleum production, and theatrical investments.
A California LLC can have the income tax transparency of a partnership on both the state and federal level, avoiding the double taxation inherent in the use of a general corporation, without the restrictions imposed on S corporations, close corporations, and limited partnerships. The use of a properly structured LLC can also limit the liability of its members, managers, and officers to their investments and commitments to invest in the LLC; this limited liability is similar to that enjoyed by corporate shareholders and limited partners, without the restrictions against management and control applicable to limited partners.
The formation and operation of an LLC is relatively simple. However, like a corporation or limited partnership, more formality in formation and operation is required than in either a general partnership or sole proprietorship. An LLC is formed by filing Articles of Organization with the Secretary of State, and must have an oral or written Operating Agreement. A written Operating Agreement is obviously preferable for certainty and understanding.
LLCs are prohibited from engaging in the banking business, the business of issuing policies of insurance and assuming insurance risks, or the trust company business. In addition, LLCs may not perform professional services. Professional services are those services that may only be lawfully rendered under a license, certificate, or registration authorized by the Business and Professions Code or the Chiropractic Action.
[a]--Management and Control
The management and control of an LLC is extremely flexible. An LLC may be managed by all of its members, or by one or more managers. The managers may be some or all of the members, but need not be members or natural persons. All that the statute requires is that, if the LLC is to be managed by one or more managers, the Articles of Organization must contain a statement to that effect. Neither the names of the managers nor the number of managers need be specified in the Articles, but if management is vested in only one manager, the Articles must so state. Even if the Articles do not vest management in a manager or managers, the Articles or Operating Agreement may restrict or enlarge the management rights and duties of any member or class of members. The Articles of Organization or the Operating Agreement may restrict or enlarge the management rights and duties of any members or classes of members.
[b]--Extent of Personal Liability
A member of an LLC ordinarily is not personally liable for any debt, obligation, or liability of the LLC arising in contract, tort, or otherwise solely by virtue of that membership. However, a member may agree to be obligated personally for any or all of the LLC's debts, obligations, and liabilities, as long as the agreement to be obligated is set forth in the Articles of Organization or in a written Operating Agreement that specifically refers to the code section authorizing liability. Furthermore, a member is personally liable under a court judgment or for an obligation of the LLC under the same or similar circumstances, and to the same extent, as a corporate shareholder may be personally liable for a corporate obligation, except that the failure to hold annual meetings or to observe formalities pertaining to those meetings does not tend to establish personal liability for members if the Articles of Organization or Operating Agreement do not require meetings.
Members are personally liable for tortious conduct, and are also personally liable pursuant to the terms of any written guarantee or other contractual obligation (other than an Operating Agreement) entered into by the member. In addition, personal liability may attach to a member who is responsible for filing tax returns or paying tax for any unpaid taxes (and any interest or penalties) if the member willfully fails to pay any taxes due. However, personal liability may be imposed only if the Board can establish that: (1) the LLC had included tax reimbursement in the selling price of, or added tax reimbursement to, the selling price of, tangible personal property sold in the conduct of its business or (2) the LLC consumed personal property and failed to pay the tax to the seller or has included use tax on the billing and collected the use tax or has issued a receipt for the use tax and failed to report and pay use tax.
Members are personally liable to the extent of any improper distribution received by a member (provided that the member had actual knowledge of facts indicating the impropriety of the distribution). Further, any member or manager voting for a distribution that violates the Operating Agreement or relevant statute is personally liable for the amount of the distribution that exceeds the amount that could have properly been paid.
[ii]--Managers and Officers
In general, managers and officers of an LLC are not personally liable for any debt, obligation, or liability of the LLC solely by virtue of that status. However, a manager may agree to be obligated personally for any or all of the LLC's debts, obligations, and liabilities if the agreement to be liable is set forth in the Articles or a written Operating Agreement that specifically refers to the code section authorizing liability. Furthermore, a manager may agree to be obligated pursuant to the terms of a written guarantee or other contractual obligation (other than an Operating Agreement) entered into by the manager. In addition, managers owe the same fiduciary duties to the LLC and its member as partners owe to a partnership and the other partners of that partnership, and may be held personally liable for any breach of that duty. Managers are similarly liable for unpaid sales taxes, and for voting for an improper distribution. Although the liability of managers for tortious conduct is not mentioned in the Act, as is the liability of members, presumably managers would also be personally liable for tortious conduct. LLC managers may also be subject to fine or imprisonment for failure to warn employees of, or to abate, serious concealed workplace dangers.
[c]--Availability of Capital
The capital requirements of an LLC ordinarily are satisfied through equity contributions from its members. In addition, loans secured by LLC property or the personal guarantees of members are often used. Because liability can essentially be limited to the amount of the investment and the availability of different classes of members to provide flexibility among investors, LLCs can be attractive to capital investors.
[d]--Continuity of Existence
In general, an LLC does not have perpetual existence. First, the Articles of Organization of an LLC must state a specified date of dissolution. This duration limitation is more apparent than real because the date can be amended. Second, an LLC must dissolve on the death, bankruptcy, retirement, resignation, expulsion, or dissolution of any member who is a manager (in an LLC managed by one or more member-managers) or any member (in an LLC managed by its members or by one or more nonmember-managers). This requirement is also somewhat illusory because organizational documents may permit a majority in interest of the remaining members to vote to continue the LLC. The foregoing requirements exist largely to assure that California LLCs receive the desired federal tax treatment. However, with the liberalized rules in effect since January 1, 1997, these requirements are no longer necessary for tax classification purposes.
In addition, an LLC is dissolved on the occurrence of any events specified in the Articles of Organization or written Operating Agreement, by a vote of a majority in interest of the members (or greater percentage specified in the Articles or written Operating Agreement), or on the entry of a decree of judicial dissolution.
An LLC with two or more members may elect to be taxed either as a corporation or as a partnership. An LLC with a single owner (i.e., a qualifying trust) may elect either to be taxed as a corporation or to be disregarded as an entity separate from its owner. If an LLC does not make an election, it will be taxed as a partnership if it has two or more members, or will be disregarded as an entity separate from its owner if it has only one member.
LLCs still are subject to the annual minimum franchise tax and must pay a graduated entity level fee based on total income from all sources.
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