Bob, a handy entrepreneur, plans to renovate condominiums, townhomes, and small apartment complexes with the help of a friend, Monet, who inherited a lot of money. They plan to flip some and rent some. Bob and Monet have heard that it is a good idea to form a company to protect them from outside claims, but are not sure if they should incorporate.
Bob states, “I don’t want a lot of paperwork and meetings. I want to get things done. For now, the business will just be the two of us.”
Monet adds, “I have a lot of money and want to protect it. Bob is the builder, I just want to put in cash and have Bob show me the money.”
Bob, “Yeah, I will scout the properties and do all of the work, but Monet will put up the cash to buy the condos and stuff, at least at first.”
It appears that a limited liability company or series limited liability company is the form of business that will best serve Bob and Monet. Here’s why.
A limited liability company (LLC) protects the owners against personal liability like a corporation. As a separate entity, the LLC will shield Bob and Monet from personal liability from outside claims stemming from business they do in the LLC. Unless they do something wild and crazy, they only will be liable for the debts and obligations of the LLC up to the amount of their respective investments in the LLC. Unless Monet offers a personal guarantee, only the money she invests in the LLC will be at risk.
And, unlike a corporation that is taxed at the corporate entity and shareholder levels, in an LLC, income taxes are only levied at the individual owner’s level as in a partnership. This “pass-through” tax treatment also will allow them to write off losses. Another perk of an LLC is that non-wage income earned in a “pass through” business like an LLC is not currently subject to income tax at the state level in Kansas. More money for Bob and Monet.
Remember, Bob doesn’t want to get bogged down with a lot of formalities. Since the activities of an LLC are governed by an operating agreement, you don’t need a lot of meetings, votes and resolutions to get business done. In an LLC, you can make management of the business simple and flexible in the operating agreement.
While Bob is hustling, Monet is simply looking for a return on her cash. In an LLC, ownership and profits interests can be different. For putting up the cash, Monet wants to own 60% of the LLC, but has agreed that since Bob will be doing all of the work, that he will get 75% of the profits. In an LLC, you can split ownership 60%-40% and profits 25%-75% (or any other ratio).
Since Bob and Monet plan to collect rent, a form of passive income, they are better off with an LLC than an S corporation. An S corporation is a form of corporation that allows for that favorable pass-through tax treatment like an LLC or partnership, but an S corporation may not have passive income that exceeds 25% of its gross receipts in 3 consecutive years, or it will be subject to taxation at the corporate level too. They don’t want double taxation.
Monet, “Hey, what about that Series LLC?”
Bob and Monet plan to make a number of real estate investments, so it may be a good idea to isolate the liabilities of certain projects in separate LLCs. A series LLC may reduce the expense of forming, maintaining, and administering multiple LLCs. In its operating agreement, an LLC may establish one or more series of members, managers or interests having separate rights and duties with respect to specified property. The organizational documents can provide for each series to have limited liability so that the debts and liabilities of a particular series will only be enforceable against the assets of such series. A claim arising out of any property should not allow a claimant to reach the assets of any other series.
Robert J. Vincze
October 21, 2016
Depew Gillen Rathbun & McInteer, LC
This article is based on hypothetical facts and is issued for general informational purposes only. It is not intended to be construed or used as legal advice.