Annual Minutes: Not Just for Corporations Anymore
Many considerations go into choosing a formal entity structure for a business. Due to its hybrid nature of partnership tax advantages and corporation-like limited liability protections, various business owners–from individuals, to closely-held family business, to joint ventures between large corporations–are looking to LLCs as the preferred entity structure.
Just as with a corporation though, the privilege of limited liability protection carries with it the obligation to conduct the business as a separate legal entity, and disregard of the formalities involved with a legally separate entity, although limited with an LLC, may create personal liability in the members for the debts or obligations of the LLC. Often the same individuals wear multiple hats at once (member and manager), and it can be difficult to clearly define roles. With former partnerships and sole proprietorships in particular, it can be easy to go back to business as usual and formalities can be lost by the wayside. Add in a closely held relationship or numerous transactions with related entities, and the protections of the LLC can be lost.
While under Oregon law LLCs are not required to follow the annual meeting and entity maintenance formalities of a corporation, it is a good idea to document major decisions of the company. A failure to maintain records will not be fatal to the existence of the LLC, but it can create problems with respect to tax issues and limited liability protection. A bit of preventative maintenance may serve to avoid larger and more costly problems in the future.
MAINTAIN LIABILITY PROTECTION
It is critical that you operate your LLC as a separate business entity. The LLC should not transfer its cash or other assets to the members except as compensation for services or capital, reimbursement for reasonable expenses incurred on behalf of the LLC, or distributions allowed under the terms of an Operating Agreement. If the LLC is using assets owned by a member, or loaning money to or borrowing money from a member, appropriate arrangements should be made and documented.
Separating the assets and liabilities of the members personally from the assets and liabilities of the LLC and documenting related party transactions will limit future potential trade creditors from recovering against the assets of the members to satisfy an LLC obligation. Detailed documentation can make it difficult for a creditor to attack the legal validity of the LLC form and preclude any piercing of the “LLC veil” which could result in recovery against the personal wealth of the members.
An LLC is generally not a separate tax payer under both state and federal law. Unless a special tax election is made, an LLC will be treated as either a partnership for tax purposes or disregarded as a tax entity (if the LLC has only one member). Accordingly, the LLC reports profits and losses on operations, while the resulting tax liability is passed-through and reported on the return(s) of the Members(s). The LLC can deduct ordinary and necessary business expenses, e.g., depreciation and wages, according to state and federal tax rules. Many common activities between an LLC and its members can have significant tax ramifications if not documented properly.
Documenting minutes of member meetings gives the members an opportunity to substantiate and explain the treatment which they intend a particular transaction to receive. Without them, justifications given at the time of audit may be seen as self-serving and given little weight. When company records are prepared close to the time the action was taken, they are of much greater value. Furthermore, minutes can aid when requesting a ruling from the IRS (i.e. an IRC 1031 exchange) or defending a position to the IRS or Department of Revenue during an audit of either the member or LLC. Moreover, the use of Minutes in the context of a family owned LLC is increasingly important as a tool to demonstrate the businesses motivation for forming the LLC and/or transferring membership interests to a younger generation.
COMMONLY DOCUMENTED ACTIVITIES
Consent resolutions or brief minutes are often used to document the following transactions:
1. Loans or leases between the LLC and the Members.
2. Compensation paid to members or managers.
3. Significant acquisitions of assets outside of the normal course of business.
4. Sales or dispositions of assets outside the normal course of business.
5. Gifting of ownership interests from one member to another.
6. Any decisions requiring consent of the members, such as:
- Change in nature of the business;
- Incurring debt outside the normal course of business;
- Entering into transactions involving a conflict of interest with the member;
- Making of optional distributions to members; and
- Deciding to continue the LLC following the death, incompetence, withdrawal, expulsion, bankruptcy or dissolution of a member.
7. Adding a new member or transferring a member’s interest in the LLC (especially important in order to prevent creditors of members or other third parties from acquiring the rights of the member).
In addition, minutes can be used to explain inadvertent mistakes or oversights in company operations, and how such actions have been remedied, such as non-LLC expenses paid from LLC funds or inadvertent income distributions disproportionate to ownership percentages. Minutes can evidence the company’s business purpose for a particular transaction, its justification for particular actions, how the members voted (this can be important if minority interest members exist), and can evidence the long-term objectives of the Company.
Maintaining regular LLC Minutes is an example of preventative legal work that generally costs a great deal less than trying to subsequently cure or explain LLC action at a later date in the scrutiny of an IRS audit or an adversarial proceeding between Members. Please feel free to contact our office if you have any questions as to whether minutes are right for your LLC or for a particular transaction.