Frequently asked questions and answers about LLC Operating Agreements
Q. Do I really need an LLC Operating Agreement if I’m the only member of the LLC (Single Member LLC)?
A. Yes - it is extremely important that you create an Operating Agreement to separate yourself as an individual from your LLC, even if you are the sole owner of your LLC. Without the formality of an Operating Agreement, the LLC can closely resemble a sole proprietorship, which does not limit your personal liability for business debts of the LLC. Without an LLC Operating Agreement , the basic operation of the LLC would then be governed by state law, which may not be advantageous to the LLC, its members, or the business it conducts.
Q. What is a Registered Agent?
A. Registered Agent acts as the representative for receiving Service of Process served upon the company within the jurisdiction of any state where the company conducts business. Service of Process is broadly construed to include any legal proceeding, legal notice, or official government communication presented to the company while it is within the jurisdiction of a state. A registered agent also provides services for helping companies stay in compliance.
Q. Why Should I Designate a Professional Registered Agent?
A. First and foremost, having a professional registered agent provides you with security and peace of mind. Lawsuits can be ticking time bombs, fraught with potential liability for your company. Ensuring each Service of Process is properly received, forwarded to counsel correctly, and on a timely basis, is the first step in defending against a default judgment which could foreclose all opportunity to have your side heard. By appointing a professional organization to handle this responsibility establishes good business practices. As a professional Registered Agent, NRAI is an expert in the field of registered agent services and statutory representation. Unlike an employee or other individual for whom acting as registered agent is only one of many responsibilities, NRAI does not quit, go on vacation, relocate, or die. Since NRAI handles the Registered Agent responsibilities exclusively for thousands of business entities, there is never any guess work with the process of handling a Service of Process.
Q. If I just formed my LLC, should I get an Employee Identification Number?
A. Generally yes - you will need an EIN if you answer "Yes" to any of the following questions:
- Do you have employees?
- Do you operate your business as a corporation or a partnership (including a multi-member LLC)?
- Do you file any of these tax returns: Employment, Excise, or Alcohol, Tobacco and Firearms?
- Do you withhold taxes on income, other than wages, paid to a non-resident alien?
- Do you have a Keogh plan (A tax deferred pension plan available to self-employed individuals or unincorporated businesses for retirement purposes)?
- Are you involved with any of the following types of organizations?
- Trusts, except certain grantor-owned revocable trusts, IRAs, Exempt Organization Business Income Tax Returns
- Real estate mortgage investment conduits
- Non-profit organizations
- Farmers' cooperatives
If you are the only member of your LLC, you will not need a separate EIN for the LLC if the LLC will not have any employees. As the sole member of a single member LLC, one can use his or her Social Security Number instead of applying for an EIN.
Q. Will I be subject to tax when I contribute money or property to an LLC?
A. In general, no gain or loss is recognized upon the contribution of money or property to a limited liability company (“LLC”) in exchange for an LLC interest. Generally, neither the contributing member nor the LLC is taxed.
Q. If I want to add a member to my LLC should I amend my LLC Operating Agreement?
A. Yes – it is very important that your LLC Operating Agreement is kept up to date and accurately describes the current business deal between the members. If not, you will be governed by an outdated Operating Agreement that will lead to issues amongst the members and possibly litigation down the road. By amending your Operating Agreement to express the updated business deal amongst the members, the new Operating Agreement will effectively amend and restate the previous Operating Agreement of the entity. In other words, the new LLC Operating Agreement will supersede any previous LLC Operating Agreements of the entity (the previous agreements will be considered cancelled) and the LLC as well as its members will be governed by the new amended and restated Operating Agreement.
Q. Do I have to file my LLC Operating Agreement with any state agency?
A. No – the LLC Operating Agreement does not have to be filed with any state agency. However, it is important that each member keep a signed copy of the LLC Operating Agreement for their records.
Q. What makes the States of Minnesota and North Dakota LLC Statute so different than all the other state LLC Statutes?
A. The Minnesota LLC Act and North Dakota LLC Act presuppose management by a board of governors. The Statutes, however, recognize that LLCs may want to be managed by the members. Therefore, the majority of Minnesota and North Dakota LLCs opt for management by the members as long as they make management decisions by unanimous vote. The Statutes also require the appointment or election of two persons who function as the LLC president and treasurer, but who are called managers. Therefore, Minnesota and North Dakota LLC should have all members manage the company and, thus, opt for the LLC to be managed by a board of management.
Q. Do the managers of the LLC have to be LLC members?
A. No – the members may appoint one or more non-members to manage the operations of the LLC. However, it is important that the members require the managers’ consent for certain crucial business/management decisions, such as amending the LLC Operating Agreement, adding a new member, or dissolving the LLC.
Q. Will a LLC member recognize gain when receiving cash distributions from the LLC?
A. Generally, the LLC and its members do not recognize gain or loss on a distribution of cash or property. Gain or loss would only be recognized when deferral is impractical or when it would result in a change of character. Typically the members pay tax on the amount of profits they are allocated not based on the amount of cash distributed.
Q. What is the difference between a “profits interest” and a “capital interest”?
A. A profits interest is often referred to as a “carried interest”. A profits interest is typically given as a reward for the performance of services, or as a way for the LLC to secure the future services of an individual. A grant of a profits interest means that the recipient receives an interest in the future profits of the LLC without being required to contribute any capital to the LLC. In contrast, when a person contributes cash or property to an LLC in exchange for an LLC interest, the person (now a member) generally receives a "capital" interest. A "capital" interest represents ownership in both the LLC’s future profits and the LLC’s current and future capital (i.e., net assets), generally upon liquidation, whereas , a profits interest represents ownership in only the LLC's future profits.
Q. How Will a Member who is also an Employee of an LLC be treated for Federal Income Tax purposes?
A. In general, a member cannot also be an employee of the LLC. Thus, a member that becomes an employee of the LLC will be treated as a member for federal income tax. The LLC should not provide a Form W-2 to the member. Instead, the member should receive a Schedule K-1 from the LLC that reflects his or her distributive share of the LLC's items of income, gain, loss, deduction, or credit for the taxable year and amounts transferred as distributions. Instead of paying FICA taxes on amount received as wages from the LLC, the member's distributive share of LLC items may be subject to self-employment tax under Internal Revenue Code Section 1401. Certain fringe benefits may be taxable to the member, including group term life insurance under Internal Revenue Code Section 79 and payments received under accident or health plans under Internal Revenue Code Section 105.
Q. Is the conversion of a “C” corporation to an LLC a taxable transaction?
A. The conversion of a “C” corporation to an LLC (classified as a partnership) is generally a taxable event. Irrespective of how the “C” corporation is converted, the conversion would be a taxable event resulting in tax to the “C” corporation as if the “C” corporation had sold its assets at fair market value. The assets received by the shareholders would then have a stepped-up basis equal to their fair market value, which would then be the basis of the assets to the LLC upon transfer.
Q. What is “phantom income”?
A. If members are allocated net profits without a corresponding distribution, the result may be “phantom income” to the members. For example, Steve and Joe form ABC, LLC. Steve and Joe each contribute $10. The LLC earns $5 of net profits, but reinvests the money in the business, and therefore has no cash to distribute to the members. In other words, Steve and Joe will be taxed on their allocable share of the $5 of net profits generated by the LLC without receiving a corresponding distribution of available cash (“phantom income”).
Q. What is a “Tax Matter Partner”?
A. The purpose of a “Tax Matter Partner” (TMP) is to provide a liaison between the LLC and the Internal Revenue Service during an administrative proceeding and to represent the LLC in judicial proceedings. Generally, only a member that has management responsibility is allowed to serve as the TMP.