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The Q-Sub

by | Mar 24, 2023 | Corporate Direct

By: Ted Sutton

What a Q-Sub is and How It Can Help Your Business

Diane has been obsessed with dogs from a very young age. She was very close with her childhood hound, and enjoyed spending time with other dogs she knew. After the hound’s passing, she vowed to make a career out of tending to our four-legged friends. She kept her word into adulthood. After graduating high school, she set up a dog store in town. Like a responsible business owner, she properly formed an LLC taxed as an S-Corp for the store.

After setting up shop, Diane soon discovered that there were very few dog grooming services in town. Given this business opportunity and her passion for dogs, Diane decided to capitalize. A few weeks later, she set up a dog grooming service in the dog store.

Over time, Diane began establishing a rapport with her clients. She noticed that many of them dropped off their dog for grooming before work and picked them up after the work day ended. What were the dogs to do after they had been groomed? Because the dogs spent all that time with her, Diane decided to provide a dog walking service.

Now Diane is in charge of three separate businesses operating under the same LLC. She has employees who work for all three and has separate obligations for each. Diane has a lot on her plate. She begins to worry about the direction of her businesses. What will she do with employee payroll? What if someone slips in the dog store? What happens if a dog bites someone while on a walk?

To address these fears, the IRS has a solution. Diane can set up Q-Subs for each of her businesses.

What are Q-Subs?

A Qualified Subchapter S Subsidiary (Q-Sub) is an S-Corp that is 100% owned by a parent S-Corp. Both the parent entity and the Q-Sub can be a corporation or an LLC. Parent S-Corps can own more than one Q-Sub, but they must make the election for each Q-Sub by filling out Form 8869 on the IRS website. This election must also be timely filed. If it is not, the Q-Sub will be taxed as a C-Corp.

Because the parent S-Corp files the tax return, the Q-Sub is not treated as a separate entity for tax purposes. However, Q-Subs are still responsible for a few things. Q-Subs must still obtain an EIN number from the IRS. Q-Subs are also separately responsible for some taxes, including employment taxes, some excise taxes, and certain other federal taxes. They should also follow all the corporate formalities (i.e. annual minutes) of a separate entity.

How they can help your business

There are a wide range of benefits that Q-Subs offer for business owners.

Q-Subs aid business owners when their S-Corp has more than one business activity. The S-Corp can limit its liability by separating its different business activities into different Q-Subs. Having this structure is certainly advantageous from an asset protection standpoint. Here, Diane only has one LLC set up for her dog store, dog grooming business, and dog walking business. Because Diane is concerned about liability, she sets up two separate Q-Subs for the dog grooming and dog walking businesses. In the event a dog bites someone on a walk, that person can only reach the assets inside the Q-Sub set up for the dog walking business. This business structure is diagrammed below:

qsub graph 1

Q-Subs come in handy when there are state and local transfer taxes that apply to sold property. In some states, transferring the property to a Q-Sub in exchange for 100% of the Q-Sub’s stock can avoid these types of transfer taxes. Let’s say that Diane lives in a state that allows these transfers without incurring tax. After setting up the Q-Sub for the dog grooming business, she wants to transfer title to the dog grooming tables into the new entity. If this transfer involves the dog store owning 100% of the dog grooming company’s stock, Diane will not have to pay any transfer taxes.

The IRS provides business owners with incentives when forming a Q-Sub. An S-Corp can deduct up to $5,000 in organizational costs the first year the Q-Sub is formed. After setting up the new dog grooming and dog walking businesses, Diane incurs $17,000 in such costs during the first year. Because the IRS offers these deductions, she can deduct $10,000 in organizational costs between the two new businesses, and deduct the remaining $7,000 in later years.

Businesses with two or more related entities use Q-Subs to minimize employee payroll taxes. When employees work for two related corporations, one corporation can set up a Q-Sub to employ the employee to avoid any double tax. Diane employs people who assist with the dog store, dog grooming, and dog walking. Instead of placing them on the payroll of all three entities, Diane sets up a third Q-Sub to employ everyone who helps with all three. This will prevent Diane from overpaying on payroll taxes. This business structure is diagrammed below:

qsub graph 2

Instead of filing separate tax returns for each entity, the parent S-Corp only needs to file one tax return for itself and its Q-Subs. At this point in time, Diane owns the dog store, dog grooming business, dog walking business, and a Q-Sub that employs everyone. With four entities, Diane thinks that tax season will be a nightmare. Fortunately, only the dog store will need to file a tax return on behalf of all four businesses. This certainly makes life easier for everyone during tax season.

Q-Sub elections are useful when S-Corps are bought and sold. If one S-Corp buys a second S-Corp, the first S-Corp could elect to treat the second as a Q-Sub.

Jack is a well-known figure and has the only doggy daycare in town. Many of the clients who buy products at Diane’s dog store give their dogs to Jack when they take a trip. At this point in time, Jack has run the daycare for over 30 years. While he also shares a passion for dogs, he decides that it is time to move on and calls it quits.

Diane views this as a perfect opportunity to add to her growing repertoire of dog businesses. Diane approaches Jack with an offer to buy the daycare. Jack is excited by this proposal. He can cash out, retire, and buy that coveted house in Hawaii to spend the rest of his days with his wife.

Both agree to the arrangement. After consultations from competent accountants and attorneys, Diane uses the dog store to buy the doggy daycare. The dog store now owns four Q-Subs, but both parties are happy. Diane has a near monopoly on dog products in town, and Jack can finally retire to Hawaii. This business structure is diagrammed below:

qsub graph 3

Lenders may want to create more lending protection by requiring S-Corp borrowers to hold loan collateral in a Q-Sub. After buying the doggy daycare from Jack, Diane realizes that she needs more kennels to house the growing number of dogs staying overnight. This will not be a cheap purchase.

Diane decides to buy the kennels on credit and approaches the bank seeking a loan. After reviewing her business credit, the bank tells Diane that they will need the kennels to be held as collateral in a Q-Sub. Fortunately, the doggy daycare business is already a Q-Sub. Both parties agree to the arrangement, and the kennels are held in the doggy daycare business as planned.

Given the numerous benefits that Q-Subs provide, business owners should consider forming them in the right circumstances. They helped Diane. And if you are faced with similar issues, they can certainly help you.

Section 1202

by | Feb 13, 2023 | Corporation, Start a Business

By: Ted Sutton, Esq.

Introduction

From a very young age, Elong Muskrat was always passionate about providing solutions to the world’s most difficult problems. Over the years, Elong had founded multiple companies in different industries. Many of them failed. However, some of them were wildly successful.

One day, Elong wanted to provide a solution to help reduce the world’s fossil fuel usage. Since cars contribute heavily to this use, Elong decided to start an electric car company. These electric cars would have all the same features without having to make the trip to the gas station.

After reducing his idea into a business plan, Elong formed Edison Electric Vehicles in 2011, a Delaware C-Corp, where he initially owned 100% of the stock.

In the following decade, Edison manufactured over 1 million electric vehicles. Because car manufacturing is an expensive endeavor, Edison’s gross assets were only worth $40 million.

In 2021, Elong was drawn to another serious issue. He noticed the ubiquity of social media and all of its negative impacts. Titter, a platform where users would constantly exchange a tit for tat, was the primary culprit. Elong wanted to purchase Titter and change its algorithms for the betterment of society. However, he would need to finance the purchase of Titter by selling his stock in Edison.

In 2022, Elong sold his stock in Edison to Riviera Motors, another electric vehicle maker, for $9 million. He then used that sum to finance his purchase of Titter.

Being an extremely smart person, Elong was curious as to the tax consequences of his stock sale. His tax advisor told him that he may qualify for the Qualified Small Business Stock (QSBS) exemption. If he does, he could save millions of dollars in taxes.

Qualified Small Business Stock

So what exactly is QSBS? Under Section 1202 of the Internal Revenue Code, a taxpayer may be exempt from paying capital gains tax when selling QSBS stock if they meet certain requirements. Each of these are listed below.

  1. QSBS Only Applies to C-Corp Stock

First, the stock must be held in a C-Corp. S-Corp stock, LLC units, and partnership interests are not eligible for the QSBS exemption.

Edison was formed as a C-Corp. The first requirement is easily met.

  1. The C-Corp Shares Must be Acquired in the Original Issuance

Second, the C-Corp shares must be acquired in the original issuance.

Because Elong owned 100% of Edison’s stock when he formed it, the second requirement is met.

  1. The C-Corp Must be a Qualified Small Business

Third, the C-Corp must be a qualified small business. A qualified small business is a domestic C-Corp which holds gross assets that have never exceeded $50,000,000.

Here, Edison’s gross assets were only ever worth $40 million. Because of this, Edison meets the definition of a qualified small business.

  1. 80% of the Firm’s Assets must be Used in Active Conduct

Fourth, a minimum of 80% of the firm’s assets must be used in active conduct, or in an ongoing business. If stock is acquired in a passive C-Corp, it cannot qualify for the QSBS exemption.

Because Edison manufactures cars, it easily meets the requirement of active conduct.

  1. The Stock Cannot be in Certain Lines of Business

Fifth, the stock of certain lines of business will not qualify for the QSBS exemption. Some of these include banking, insurance, farming, leisure and hospitality, and other professional businesses.

Because Edison manufactures cars, it does not fall into any of the aforementioned categories. It still qualifies for the QSBS exemption.

This is all great news for Elong. His stock qualifies for the QSBS exemption because it has met the aforementioned requirements. He can save money by not having to pay the capital gains tax associated with the sale of stock. However, how much Elong saves depends on when the stock was held and how much the stock sold for.

  1. When the Stock was Held

If the taxpayer acquires QSBS stock after September 27, 2010, and holds it for more than 5 years, the taxpayer can exclude 100% of the capital gain upon its sale.

If the taxpayer acquires QSBS stock between February 18, 2009 and September 27, 2010, and holds it for more than 5 years, the taxpayer can exclude 75% of the capital gain upon its sale.

If the taxpayer acquires QSBS stock between August 11, 1993 and February 18, 2009, and holds it for more than 5 years, the taxpayer can exclude 50% of the capital gain upon its sale.

Elong formed Edison in 2011 and sold his Edison stock in 2022. Because of this, Elong may exclude 100% of the gain.

  1. Maximum Excludable Gain Recognized

The IRS sets limits on how much a taxpayer can exclude upon the sale of QSBS stock. The maximum eligible gain that a taxpayer can recognize is capped at the greater of $10 million, or 10 times the aggregate adjusted basis in the stock.

Here, because Elong sold his Edison stock for $9 million, he is able to exclude the entire gain associated with its sale. 

Conclusion

If they meet the requirements, qualifying for QSBS can be advantageous to taxpayers who acquire and sell stock in smaller C-Corps.

The Corporate Transparency Act

by | Jan 23, 2023 | Asset Protection

The Corporate Transparency Act

By: Ted Sutton, Esq.

The Final Rules Are In – New Requirements Ahead for Every Corporation, Limited Partnership, and Limited Liability Company 

Introduction 

Powertainment, LLC is a profitable company that helps aspiring entrepreneurs become the best version of themselves. It was founded by Patrick, Tom, and Adam. The three of them each agreed to own 1/3 of the LLC’s membership interests. Robert, a friend of theirs, comes to the company 45 days later. While he doesn’t own any membership interests, he has agreed to be the manager of Powertainment.

Each of the four men have different backgrounds and different areas of expertise. This wide range of available knowledge has resulted in Powertainment’s success. On top of employing 18 employees, the company generated over $6 million in revenue in the past year.

Tom recently found out from a friend that Congress passed the Corporate Transparency Act (or ‘CTA’). Nervous of what it would do to Powertainment, he went to the other three to voice his concerns. How would it affect their business? How would they have to report personal information to the government? What penalties would they face if they failed to comply?

The answers to each of these questions follow.

Corporate Transparency Act 

The CTA was enacted (said the bill’s sponsor) “to combat malicious actors using shell corporations” to move illegal funds throughout the United States. Many policy makers believe the CTA will deter criminals and their criminal acts. However, the effectiveness of this Act is yet to be seen.

The CTA requires both companies and beneficial owners to submit a report to the Department of Treasury’s Financial Crimes Network (FinCEN). Both requirements are discussed below.

Company Requirements 

So which companies are required to file? Under the CTA, companies must file if they are either formed by filing a document with the secretary of state or similar tribal office, or formed in a foreign country that’s registered to do business in the US. The Act also states many exemptions, most notably the “large operating companies” exemption. The requirements for being a “large operating company” include employing more than 20 full-time employees, accruing more than $5 million a year in gross receipts or sales, and operating from a physical office in the US. If your business meets these three criteria, you are exempt from filing.

While Powertainment meets two of the three requirements of a “large operating company”, it only employs 18 people. Thus, the exemption doesn’t apply to them. Powertainment must still report to FinCEN.

Beneficial Ownership Requirements 

So who exactly is a beneficial owner of the company? The CTA lists out two criteria, each being sufficient on its own to meet the Act’s definition. The first criteria mandates FinCEN notification for individuals owning or controlling at least 25% of the reporting company’s ownership. The second criteria requires reporting someone (and not necessarily an owner) who exercises “substantial control” over the reporting company.

This begs the question: What constitutes having “substantial control” over a company? It can encompass many different forms. It can mean serving as a company officer, having the power to appoint or remove members, making decisions for the company, and exercising “substantial influence” over the company’s important matters. In addition, the government can also look at other characteristics not listed to determine if an owner has “substantial control” over the company. Clearly, this definition is not entirely definite.

Because Patrick, Tom, and Adam each own 1/3 of the LLC, they automatically meet the 25% requirement. They must report as individuals. On the other hand, Robert does not own any interest in the LLC. But because Robert serves as the manager and is thus a company officer of Powertainment, he must still report. And, because he came to the company after the first report was filed, Powertainment must file an amended report within 30 days of his hiring.

What must be Reported 

There are two reports that need to be submitted to FinCEN. First, companies must report four information items. These include:

  • The company’s name and any trade name or DBAs (if applicable)
  • The business street address
  • The formation jurisdiction, and
  • A “unique business number” (This can be a company’s EIN number from the IRS)

Second, beneficial owners must report four information items. These include:

  • The name of the beneficial owner
  • Their birthdate
  • Their residential street address, and
  • A “unique identifying number” (This can be either a passport or a driver’s license, a copy of which must be submitted)

For companies formed before January 1, 2024, they must report this information before January 1, 2025. For companies formed after January 1, 2024, they must report this information within 30 days after receiving notice of the entity’s creation. As well, anyone who files the documents creating the company, such as a lawyer or paralegal, must have their information reported.

Because Powertainment was in existence before January 1, 2024, these reports are due by January 1, 2025. Here, Powertainment would have to report all four information items as the company. On top of this, Patrick, Tom, Adam, and Robert would each have to report all four information items as beneficial owners. A total of five reports, all for one business. For businesses with more people having substantial control, that number is even higher. If Powertainment has a change in ownership, or hire more people with substantial control over their operations, they have 30 days to file an amended report.

Penalties for Not Filing 

What’s the point of passing a federal law if there are no penalties? The CTA has its fair share of them, and they are steep if you don’t report. Fines can be up to $500 a day after the reports are due and can even accumulate up to $10,000. Even worse, you can be sentenced to prison for up to 2 years for failing to comply. Mere negligence here can lead to a criminal violation.

Let’s say that the Powertainment owners shift their ownership percentages and bring on a new vice president who now exercises substantial control. As mentioned, an amended report to FinCEN is due within 30 days. Like many Americans who forget about the numerous federal reporting requirements, if the Powertainment team forgets to report they may soon owe the government $10,000 in penalties. The government may grant no leeway in this situation. When the Act takes effect, everyday Americans could face significant consequences for not complying.

Conclusion

The CTA has far-reaching effects. Almost every entity ever formed will have to comply in some fashion. Will Congress’s aims actually work? Or will the bad guys figure out a way around the rules, leaving millions of American businesses with yet another government burden?

The CTA seems unlikely to be repealed. Fortunately, we at Corporate Direct are here to help. Starting in January of 2024, we can prepare your initial and amended reports and submit them to FinCEN. Feel free to contact us for more details.

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How LLCs Can Protect Doctors

by | Dec 28, 2022 | Asset Protection, Forming an LLC

By: Ted Sutton

Doctors are frequent targets of medical malpractice suits. This is why many of them have malpractice insurance to cover these claims. But what happens when the insurance does not cover the full amount? In this situation, the last thing doctors want is to have their personal assets exposed. Fortunately, doctors have a few options to protect their assets.

Forming an LLC for their Practice

The first thing doctors can do is set up an entity for their practice. The entity must be formed in the state where the doctor is licensed to practice, and each state has different requirements. Some states allow doctors to simply form an LLC for their practice. Others such as California require doctors to set up a Professional Corporation (PC). A third group of states, including Illinois, require doctors to set up a Professional Limited Liability Company (PLLC). For the latter two categories, entity owners must be licensed members of their respective profession.

Forming an LLC for their personal assets

Using an entity for a medical practice is useful to protect against a slip and fall or other accidents on the premises. But what happens when the doctor is sued personally? A malpractice claim is personal, meaning the doctor can’t hide behind the entity. The patient, after collecting against malpractice coverage, can reach the doctor’s personal assets. Having a separate LLC for personal assets can prevent an easy taking.

To insulate from personal liability, many doctors use LLCs to hold title to personal assets, including stock portfolios and real estate holdings. But the patient may still attach the doctor’s interest in the LLC to pay their claim. Choosing which state to form the LLC makes the biggest difference in what the patient can collect.

Form an LLC in a Strong State

Some states, including Wyoming, offer better protection for one simple reason: the charging order. This order only allows the patient to collect any distributions the doctor may receive, and gives them no right to participate in the LLC’s management.

In Wyoming, the charging order is the only way that the patient can collect anything from the LLC. You do not have to make any distributions from a stock portfolio. So if no distributions from the LLC are made, the patient collects nothing. This can aid doctors, especially if the LLC holds valuable assets.

Other states, including California, have weaker protections. Contrary to only allowing the patient to receive distributions, a California court may force the sale of the doctor’s LLC to pay the claim. Do doctors want this to happen? Of course not, and fortunately, this scenario can be minimized. By forming the LLC in a state with better protection, the doctor is better protected.

Conclusion

Doctors must not only consider an entity for their practice, but also an LLC for their personal assets. When faced with a claim, these considerations make the difference between how much or how little a claimant can collect.

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Multi-Member LLCs: Structure and Issues

by | Oct 17, 2022 | Forming an LLC, Start a Business

By: Ted Sutton

LLC structure with regard to members

Graham has been a prominent real estate investor for over a decade. After coming from humble beginnings, he has built a large portfolio that holds over 100 properties. He decided to teach people how he did it, so he started making YouTube videos. Graham figured this would be a good opportunity for him to both educate a younger audience and generate a second stream of passive income. Over time, Graham began to build a large following. He also met many like-minded YouTubers along the way. He became especially close with Jaspreet, Marko, and Natalie.

Given their popularity, Graham and other three YouTubers decided to make a financial education super-conglomerate. A one-stop shop for financial education organized under one business entity. This fearsome foursome formed an LLC, contributed capital, and received membership interests in return.

This article illustrates how multi-member LLCs are formed, managed, and continued after a member departs. Each will be discussed in detail below, continuing with the example above.

What is a member? 

A member is an individual or an entity that owns an ownership interest in an LLC.

Here, Graham, Jaspreet, Marko, and Natalie are all members. A chart reflects their membership interests:

Multi Member LLC Graphic 1

When Entities Are Members 

LLCs are also allowed to be owned by another legal entity. In many cases, they are owned by another LLC. They can also be owned by a corporation.

The entity’s ownership must be reflected in both the Operating Agreement and the meeting minutes. When one LLC owns another LLC, the Manager from the entity with the authority to sign should sign both the Operating Agreement and minutes.

Marko has a very large stock portfolio. Because he is concerned about personal liability, he set up an LLC to hold his paper assets and another to hold his syndication interests. These two are owned by a passive Wyoming holding LLC. He then decides to have his Wyoming holding LLC own the new Financial Education LLC. This provides an extra layer of protection between Marko personally, and his interest in the financial education LLC. He signs both the Operating Agreement and the meeting minutes as the manager of his LLC. A chart illustrates Marko’s ownership interest below:

Multi Member LLC Graphic 2

If Marko is sued personally (after a car wreck, for example) a victim will have to fight through Wyoming’s very strong protections to try and get at Marko’s paper assets, syndication and financial education interests.

Ownership percentages 

Members can own different ownership percentages in an LLC. Generally, ownership percentages are based off the member’s capital contributions. However, members are also free to allocate the ownership percentages that have an economic basis in any manner that makes economic sense.

Graham has been a successful real estate investor who has a large portfolio. Since his net worth is significantly higher than the remaining members, he agrees to contribute $1 million to the Financial Education, LLC. Because Graham also manages each of his rental properties, he decides to take a more passive role in the LLC. He agrees to own a 10% membership interest. Jaspreet, Marko, and Natalie agree to run the operations and own 30% each. But Graham wants a priority return on his money, since he is putting up the most. It is agreed that he will receive the first $1,500,000 in profits, his money back plus 50%. These interests are reflected below:

Multi Member LLC Graphic 3

The LLC taxed as a partnership allows for priority returns like this. Be sure to work with your CPA on these issues.

Who is the manager? How to decide who will act as the Manager. 

The manager is, quite simply, a person who manages the LLC. LLCs can have more than one manager, and they also provide for two different management structures. 

Member-Managed LLC

The first is member-managed. In a member-managed LLC, the manager can only be one of the members. A member managed board can be all of the members. Management is determined by a vote of the members during a meeting. Members who want to have more control in the LLC may prefer this structure.

If their Operating Agreement specifies that the LLC is member-managed, then only Graham, Jaspreet, Marko, and Natalie are allowed to manage the LLC. 

Manager-Managed LLC

The second option is manager-managed. In a manager-managed LLC, the manager can either be one of the members, or the members can elect to hire an outside manager. This structure is ideal where members prefer a more passive role in the LLC’s affairs. We prefer manager management to better clarify and separate the roles between ownership and management, which can help solidify the corporate veil of protection.

Let’s say the LLC’s Operating Agreement states that the LLC is manager-managed. Kevin is a friend of the group and is also very passionate about financial education. He is known for his hard work and wants to be involved with the LLC. However, none of the other members want Kevin to own a membership interest. This doesn’t bother Kevin one bit. At their next meeting, the four members agree to elect Kevin to manage the LLC’s affairs. Everyone is happy. Kevin gets to do the management work nobody else wanted to do, and the four members get to watch their business grow. A chart illustrates this below:

Multi Member LLC Graphic 4

Member Leaves 

As is true with life, membership interests in LLC constantly change. LLC members can leave for a number of reasons, and there are several different ways they can leave, and how the remaining members can handle the ownership of the departed member’s interests. The most common method is including a right of first refusal provision in the Operating Agreement, described below.

Right of First Refusal

A multi-member LLC may select a right of first refusal provision. This procedure gives the remaining members first priority to buy a departing member’s interest. This helps the remaining members because have a say in who can take the departing member’s place. For this reason, we include such a provision in our Operating Agreement.

Here’s how it works. In the event that a departing member receives an offer to buy their interest from a third party, the departing member must first take that same offer to the remaining LLC members. The remaining LLC members then have the right to buy that interest on the same terms proposed by the third party. If the remaining LLC members refuse that offer, then the third party can buy the departing member’s interest on the same terms.

Let’s assume that the honeymoon period ends and relationships begin to sour. Graham is disappointed with the direction of the LLC and the other members’ philosophies. He certainly regrets contributing additional capital for a smaller ownership percentage since his priority return has not materialized. Graham’s friend, Andrei, learns of his discontent and offers to buy his membership interest. Andrei has always wanted to be involved in a financial education business. He also gets along with the remaining members. Andrei puts in an offer to buy Graham’s 10% membership interest for $750,000.

The Operating Agreement has a right of first refusal provision. Graham then goes to Jaspreet, Marko, and Natalie with Andrei’s offer. If the three members agree to buy the interest, they can pay $250,000 each to own the remaining 10% membership interest. If Jaspreet, Marko, and Natalie decline the offer (the more likely outcome here), then Andrei buys Graham’s 10% interest for $750,000. Andrei then must be voted in by the others to become a full member of the LLC with a 10% ownership interest and the rights to the priority return. A chart illustrates this process below:

Multi Member LLC Graphic 5

A Member Dies 

Another fact of life is that people die. When an LLC member passes away, there are several ways their interests can transfer. Each are described below. These transfers may also apply when a member leaves the LLC.

Jaspreet left the United States to visit family in India. However, his plane had mechanical issues en route and crashed into the ocean. Nobody survived. The remaining members were not only devastated but also unsure what to do with Jaspreet’s membership interest. Fortunately, the Operating Agreement may tell them how to proceed. 

Right of First Refusal 

As discussed, before, the company and the other Members may have the first right in the Operating Agreement to buy the deceased member’s interests. This can be useful if the other members don’t want to have Jaspreet’s heirs inside the business. The Operating Agreement provides a method for valuing Jaspreet’s interest. With Jaspreet’s estate paid off (in some cases overtime pursuant to a promissory note) the business continues with the working members.

Estate Transfers 

If allowed by the Operating Agreement, Jaspreet’s Estate (and/or other beneficiaries) may be allowed to own an interest in Financial Education LLC. The estate can always sell the interest to the other members if needed. Assume that Jaspreet’s wife Alex holds onto the LLC interest, then the chart below illustrates the ownership:

Multi Member LLC Graphic 6

Agreement is Silent 

If the Operating Agreement is silent on a certain event, then state law governs. Some states require that the LLC must be dissolved entirely when a member dies.

Let’s assume that the LLC is formed in a state with such a law, and the Operating Agreement is silent on the event of death. After Jaspreet’s death, the LLC is required to be dissolved. It doesn’t matter that Andrei, Marko, and Natalie are still alive. Their financial education business must end.

To avoid this unfair result, it is important to include Operating Agreement provisions that govern how membership interests transfer upon death or departure.

Conclusion

The above examples demonstrate that the LLC provides flexibility with regards to formation, governance, and membership departure. When forming a multi-member LLC, it is important to have a well-drafted Operating Agreement that spells out what to do when each event happens. Corporate Direct can help with all these issues. Schedule your free 15-minute consultation with an Incorporating Specialist to find out more!

 

 

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