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The Mistake of a Business Owner Regarding LLCs

Hypothetical 1:  Sarah starts Paint by Sarah, LLC by filing the articles of organization with the Minnesota Secretary of State and obtaining the EIN herself. Because she is under the mistaken impression that her husband (who has nothing to with the business except to listen to his spouse vent) is automatically an owner of the business, she states the the LLC agrees to be taxed as a partnership. However, she never files partnership returns, which creates huge tax consequences and penalties to her.

Moral of this hypothetical story: The application for an EIN looks deceptively simple, but it is often a minefield just waiting to explode. Work with your accountant to obtain the EIN and other required tax numbers.

Hypothetical 2:  Katrina makes masks for people to wear to Venetian inspired balls. She then meets Gail who makes hats for events such as the Kentucky Derby and the Ascot. They decide to form a LLC together. They agree to be 50/50 partners, but do not have an operating agreement or a separate buy-sell agreement (note: the latter is the business owners’ prenuptial agreement). Ten years after starting the LLC, Gail decides that she is no longer going to work for the company, but instead, she is just going to take her 50% of the profits (which generally means 50% of the revenue that Katrina brings to the business). Katrina is understandably upset.

Moral of this hypothetical story: If you are an owner of an LLC that has more than one owner it is in your best interest that you have an operating agreement that includes buy-sell provisions (referring to what happens to each owner’s interest upon divorce, disability, death, retirement, etc.) that includes what happens if one owner decides he/she is no longer going to work for the company.

Hypothetical 3:  Chad owns a construction company with Joe and Tyler. They are a LLC, but are taxed as an S-Corp. There is no operating agreement and there is no buy-sell agreement (note: a buy-sell agreement is the business partners prenuptial agreement). Rather, the parties just know that Chad owns 50% and Joe and Gabe each own 25%. Without Joe and Gabe knowing, Chad transfers his 50% interest to his family company for estate planning purposes. By doing so, the LLC loses it’s S-corp tax election and will be taxed instead as a C-Corp.

Moral of this hypothetical story: Make certain that you are working with your business attorney along with your estate planning attorney and your CPA.

Spangler and de Stefano, PLLP assists business owners with most aspects related to their business, including estate planning, business succession planning and elder law.

The material contained herein is for informational purposes only, and is not intended to create or constitute an attorney-client relationship between Spangler and de Stefano, PLLP and the reader. The information contained herein is not offered as legal advice and should not be construed as legal advice.