Category Archives: LLC

Non-Tax Factors of Business Formation Minnesota

Posted on by

In choosing the most appropriate form of organization, the business owner will want to consider a variety of factors, including: complexity and expense of organizing the business; liability of the business owner; distribution of profits and losses; management control and decision making; financing startup and operation of the business; transferability of ownership interest; continuity of the business entity following withdrawal or death of an owner; complexity and expense of terminating or reorganizing the business; extent of governmental regulation, and tax considerations.

All businesses, regardless of their form, will encounter certain organizational costs. These costs can include developing a business plan, obtaining necessary licenses and permits, conducting market research studies, acquiring equipment, obtaining the advice of counsel, and other costs.

Sole Proprietorship. The sole proprietorship is the simplest form of organization, and the least expensive to establish. There are no statutory requirements unique to this form of organization. From a regulatory standpoint, the business owner only needs to obtain the necessary business licenses and tax identification numbers, register the business name, and begin operations. Many individuals begin their business as a sole proprietorship. As the business expands or more owners are needed for financial or other reasons, a partnership or corporation may be formed.

Partnership. A general partnership is more complex to organize than a sole proprietorship, but involves fewer formalities and legal restrictions than a limited partnership, corporation, or limited liability company. Basic elements of partnership law are established by statute, but most issues can be determined by agreement of the partners. A written partnership agreement is highly recommended, but is not legally required. Factors to consider in a partnership agreement are listed in a later section of this Guide. The partnership agreement is not required to be filed with any governmental entity. Note that under the Revised Uniform Partnership Act (RUPA) of 1997, Minn. Stat. § 323A, partnerships have the option of filing with the Secretary of State certain statements regarding the authority and liability of partners as well as the status of the partnership. A limited partnership must meet specific statutory requirements at the time of organization, and the offering of ownership interests in the limited partnership is subject to tax and securities laws. Accordingly, the limited partnership will be more complex and expensive to organize than a general partnership.

Limited Liability Partnership and Limited Liability Limited Partnership. An existing general partnership may elect limited liability partnership status by filing a limited liability partnership registration with the Secretary of State. Such registration is effective for an indefinite period of time. Limited liability limited partnerships are also permitted. Anyone interested in forming an LLP or an LLLP is advised to seek the advice of counsel. Note also under RUPA, limited liability limited partnership registrations have an indefinite term, although the Secretary of State will revoke LLP or LLLP status if the required annual registration is not filed. Limited liability partnerships generally follow partnership law with specific exceptions as provided by law.

Corporation. The corporation is a formal and complex form of organization, and accordingly can be expensive to organize. Procedures and criteria for forming the corporation and for its governance are established by statute. FAILURE TO FOLLOWTHE STATUTORY FORMALITIES CAN RESULT IN LOSS OF CORPORATE STATUS AND IMPOSITION OF PERSONAL LIABILITY ON THE INCORPORATORS OR SHAREHOLDERS. The 5 corporation faces further complexity in that the election of 5 corporation status for federal tax purposes must be filed with the Internal Revenue Service in a timely fashion. In addition, care must be taken in the transfer of shares not to inadvertently lose 5 corporation status. Because of the complexities involved in incorporating, corporations often will make greater use of professional advisors, which will increase costs. Other costs associated with incorporating include filing fees, which are greater for corporations, and the costs associated with tax compliance and preparing various government reports. If the corporation does business in other states, it generally will be required to register to do business in those states, thus further increasing the cost and complexity of incorporation. And, if the corporation will raise capital by selling securities, the compliance costs involved will be substantial. Minnesota has attempted to simplify the incorporation process by including in the Minnesota Business Corporation Act all of the rules pertaining to the internal governance of the corporation. A corporation that agrees to be governed as specified in the statute need only file standard form articles of incorporation with the Secretary of State. The corporation that wishes to vary the statutory requirements generally must do so in its articles of incorporation. Prior consultation with legal counsel can assist the incorporators in determining which approach is most appropriate for the corporation. Further information on incorporating appears in the section of this Guide titled Forming a Minnesota Business Corporation.

Limited Liability Company. The limited liability company combines aspects of the partnership and the corporation. It can be expected to be similar to a corporation in complexity and cost to organize. As with a corporation, the procedures and criteria for forming a limited liability company are specified by statute. FAILURE TO FOLLOW THE STATUTORY REQUIREMENTS CAN RESULT IN LOSS OF LIMITED LIABILITY COMPANY STATUS AND IMPOSITION OF PERSONAL LIABILITY ON THE ORGANIZERS AND MEMBERS OF THE COMPANY. There is very little case law to guide organizational and operational decisions although the limited liability company law is modeled on the business corporation law. For this reason, owners of a limited liability company may need to consult often with their professional advisors or an attorney, increasing their costs. Under the Treasury Regulations dealing with the federal income tax classification of business entities, the organizers of a Minnesota limited liability company have some flexibility in choosing the tax status of their entity. Professional advice in this area is strongly encouraged. RR. § 322B. In that case, standard form articles of organization may be used to organize the company.

Forming a Business in Minnesota: Limited Liability Company (LLC)

Posted on by

A Minnesota business also may organize as a limited liability company. A limited liability company elects to be treated for tax purposes as a sole proprietorship (disregarded entity), partnership, or corporation. A limited liability company may have one or more members. As described further in the section on tax considerations in choosing the form of organization, organizers of Minnesota limited liability companies have some flexibility with respect to the federal income tax treatment of such entities due to the Treasury Regulations on entity classification. These Regulations appear in 26 C.F.R. § 301.7701-1 et. seq. A limited liability company with more than one member may choose to be taxed as a partnership or a corporation. In either event, the limited liability company must obtain both federal and state tax identification numbers, even if it has no employees.

A limited liability company with only one member may be taxed as a corporation or as a sole proprietorship. A limited liability company that chooses to be taxed as a sole proprietorship generally does not obtain a federal or state tax identification number unless it has employees in which case it will obtain tax ID numbers and use them to remit unemployment taxes. Business income and losses of the limited liability company that chooses to taxed as a partnership or as a sole proprietorship may be passed through to the owners of the business. The income of a limited liability company that chooses to taxed as a partnership or as a sole proprietorship is included in the taxable income of the member or members and taxed at the owner’s individual tax rate. Like a corporation, a liability for business debts and obligations generally rests with the entity rather than with the individual owners. A limited liability company is not subject to many of the restrictions that apply to S corporations. All members of a limited liability company may participate in the active management of the company without risking loss of limited personal liability. It is managed by a board of governors and an active manager.

Forming a Business in Minnesota: Sole Proprietor and Partnerships

Posted on by

Sole Proprietor

In a sole proprietorship, the business is owned controlled by one individual. That person alone receives the profits and bears the losses from the business, and that person alone is responsible for the debts and obligations of the business. Income and expenses of the business are reported on the proprietor’s individual income tax return, and profits are taxed at the proprietor’s individual income tax rate. If a husband and wife wish to own a business together, they must either form a partnership, corporation or limited liability company (in order to have each of them be an owner of the business) or a sale proprietorship (in which case only one of them be an owner of the business). A married couple who jointly operate an unincorporated business and who file a joint federal income tax return may have a qualified joint venture and can elect not to be treated as a partnership for federal tax purposes provided that the husband and wife are the only members of the joint venture and that both husband and wife materially participate in the running of the business. In this case each spouse will report his or her share as a sole proprietorship.

The sole proprietorship is the simplest form of organization, and the least expensive to establish. There are no statutory requirements unique to this form of organization. From a regulatory standpoint, the business owner only needs to obtain the necessary business licenses and tax identification numbers, register the business name, and begin operations.

Partnership

A general partnership is a business owned by two or more persons who associate to carry on the business as a partnership. Partnerships have specific attributes, which are defined by statute. All partners in a general partnership share equally in the right, and responsibility, to manage the business, and each partner is responsible for all the debts and obligations of the business. Distribution of profits and losses, allocation of management responsibilities, and other issues affecting the partnership usually are defined in a written partnership agreement. Income and expenses of the partnership are reported on federal and state “information” tax returns, which are filed by the partnership. The partners are taxed on their respective share of the partnership’s profits at their individual income tax rates.

Minnesota partnerships are formed and governed only by the Revised Uniform Partnership Act (RUPA), Minn. Stat. § 323A. Partnerships formed under former partnership law are now subject to this chapter. If you were formed under former laws and have not yet consulted with an attorney about the changes in partnership law, you are encouraged to do so immediately.

Starting a Small Business – How to Limit your Liability

Posted on by

Previously in the Starting a Small Business Series we discussed the importance of limiting your liability as a Minnesota small business owner. In this post we will discuss how small business owners can best limit their liability. The first step to limiting your personal liability is to create a limited liability entity. A local twin cities attorney can help you with that.

Once your company exists, the second step is to create its structure. The most important reason to do this is to avoid personal liability for company debts, also known as “piercing the corporate veil.” In Minnesota, the courts may apply one of three different “tests” to determine whether or not to pierce the veil in any given circumstance.

The Agency Test: under this test a Plaintiff must show that the owner of the business exercised a significant degree of control over the company’s decision making;

The Alter Ego Test: here the court will pierce the veil to prevent fraud, illegality, or injustice, or when not doing so would defeat public policy or shield someone from liability from a crime;

The Instrumentality Test: a Plaintiff must show that the parent company exercises extensive control over the acts of a subsidiary, giving rise to the claim of wrongdoing.

Unfortunately, the courts have done very little to explain these tests. However, the Minnesota Supreme Court did provide a list of factors that they consider when determining whether to look through the limited liability entity. Those factors include: insufficient capitalization for purposes of the corporate undertaking, failure to observe corporate formalities, nonpayment of dividends, insolvency of the debtor corporation at the time of the transaction in question, siphoning of funds by the dominant shareholder, nonfunctioning of other corporate officers and directors, absence of corporate records, and existence of the corporation as merely a façade for individual dealings. To complicate matters further, the Court has said that in addition to a number of the previously mentions factors being present, there also must be an “element of injustice or fundamental unfairness.”

What all of this amounts to for the Minnesota small business owner is that they must not only create their business, but they must observe the organizational formalities imposed by state law. They must do things such as elect directors, adopt bylaws, elect officers, adopt banking resolutions etc. While it may seem silly for a single member business to hold a meeting as the sole member of the board, and then another as sole shareholder (or sole Member if an LLC), this is what is required under Minnesota law for a small business owner to protect themselves from personal liability.

Any twin cites attorney can help the small business navigate these confusing waters, and it is highly recommended that you consult one before moving forward with your business transactions.

Differences Between an S-Corporation and Limited Liability Company

Posted on by

There are three main differences between an S-Corporation “S-Corp.” and a Limited Liability Company “LLC”. These differences are (1) ownership restrictions, (2) the treatment of self-employment tax and (3) the distribution of profits and losses.

The ownership restrictions for an S-Corp. are much more substantial than those of an LLC.  Pursuant to IRS code section 1362, an S-Corp. cannot have more than 100 shareholders. While this provision is very limiting, it does allow for a family to count as one shareholder. S-Corps. also have a limitation on who can be a shareholder. A shareholder must be either US citizens or resident aliens. What this means is that no corporations or LLCs may be a shareholder of an S-Corp. Finally, an S-Corp. may only have one class of stock.  However, the S-Corp. can differentiate whether the shareholders are able to have voting rights in that one class of stock.

Continue reading →

The Need for Member Control Agreements for LLCs

Posted on by

Often, new business owners question whether they need a member control agreement. They commonly don’t know of the possible pitfalls of operating without one. In this article we will address why a member control agreement for an LLC is a necessary component for the business. A member control agreement should address four primary issues.

Determine Ownership
Operational Control
Succession Planning
Protecting Limited Liability of Single Member LLCs

While they can, and usually do address more, these four will be covered below, as they are necessary components to most LLCs.

Continue reading →

Benefits of a Limited Liability Company

Posted on by

When determining which entity an individual or group should form, one of the top choices is a limited liability company, also known as an “LLC”. While there are many benefits to forming an LLC, this post will discuss four of the more prominent ones.

The first benefit, and arguably the most important, can be found within the entity’s name. That benefit lies in the “limited liability” of the company’s owners. Limited liability means that owners are not personally responsible for the acts, debts, liabilities or obligations of the company based on his or her status as an owner. One important exception to this rule is that an owner will lose the liability shield provided by the LLC if he or she personally guarantees the debts of the company. This issue most commonly occurs when a small business takes out a loan from a lending institution. Often, the lending institution will not authorize the loan without a personal guarantee.
Continue reading →