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LLC Mini Course No. 4

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A Mistake to Avoid in Forming an LLC

(Don’t Lose Your Asset Protection)

Today we are going to discuss the essential elements of an LLC, and how we use them to your advantage.  The lesson to be learned from this discussion is that “You better watch out.”  There are four elements in a corporation and if you want true LLC protection, you need to understand those elements and how they work.

FREE WEBINAR TRAINING: Maximizing Your LLC’s Money Making and Asset Protection Poten​​​​​​​tial

Forming an LLC that Does Not Offer Asset Protection

One of the big named business families in our state recently brought their “family LLC” into my office for review.  The patriarch of the family was near death, and one of the daughters asked me to review everything in preparation for Dad’s death.  They had the best law firms and accounting firms in the state, but she just wanted me to look at everything.  When we got into their paperwork, I figured out they had a disaster.

Their LLC lacked “continuity of life.”  By law, their LLC would die when one of the members died.  On Dad’s death the LLC would be gone.  I told the daughter it was easy, and we could reconstruct the LLC to continue after Dad’s death.  But, I started to ask more questions.  A son had died three years earlier.  He was a member (owner) of the LLC.  By law, that LLC had terminated three years earlier when the son had died. For three years without knowing it, this very sophisticated business family had been operating their multi-million dollar business not as an LLC, but a partnership. They didn’t have an LLC as they thought, they just had a piece of paper.

If they had been sued, the plaintiff’s attorney would have simply come in and taken everything, both company and personal assets. They didn’t have an LLC. They had lost their liability shield.  They hadn’t been sued, they had paid their taxes, and none of the other major asset protection threats had occurred, so everything was ok.  Remember, I told you a lawsuit isn’t your biggest asset protection threat by any means.

Elements of an LLC

I hope by now that you realize that you need to understand the essential elements of an LLC before you can see if yours will pass the “basic” legal test.

I am not talking about the bells and whistles that beef up asset protection and money-making opportunities that your LLC can utilize.  I’m asking, “Do you even have an LLC? Or do you just have a piece of paper?”

There are dozens of websites and thousands of attorneys dedicated to “setting you up with your LLC” (“setting you up” are the operative words there). Only a select few will lead you through the discussion you’re getting in this mini course.

Before we get started, you’ve got to understand the basic elements of a corporation, because an LLC can be thought of as a “defective corporation.”

Corporate Building Blocks

There are four elements that define a corporation.  The corporation has to have all four of these elements identified in its by-laws.

  1. Limited Liability
  2. Transferability of Interests
  3. Continuity of Life
  4. Centralized Management

1. Limited Liability

Obviously, the corporate shield (limited liability) that protects the officers, directors and shareholders is a big deal. That’s why most people get a corporation or an LLC. (The tax opportunities are just as important, but they are not on the list.)  Note that the corporate shield for an LLC is identical to that of a corporation.  The requirements for having the corporate shield protect you are the same in a corporation and an LLC.  That means the same formalities that have to be followed in a corporation also have to be followed in an LLC.

My state has a specific law that says LLCs don’t have to follow the corporate formalities, yet every day the courts set aside the limited liability and let the creditors of an LLC go after the owners personally.  What happened?  Well, in spite of the law stating no corporate formalities are required, the courts still require the formalities, because the basic argument for limited liability shielding is always “is this a real company or the owner’s alter ego”?  The way you prove that it is a real company is by following the corporate formalities.  Even in the LLC world, you’ve got to prove that your LLC isn’t just your alter ego if you want the limited liability shield (corporate shield).

2. Transferability

Transferability of interests is also a big deal. Corporations sell stock, and that stock is traded and traded and traded. That is transferability. All of the big New York Stock Exchange corporations have transferability because the interests (stock) are transferable.  In fact, one of the required elements of a corporation is transferability of ownership.

3. Continuity of Life

Continuity of life is a confusing concept. When you set up your corporation or LLC, you will choose a “life” for the company. It will be a 20 year life (term), or some other stated term, or you could say your company will go on in perpetuity. That’s not “continuity of life.” Continuity of life means that the company will survive the death of one of its owners. If an owner of IBM stock dies, IBM goes on just fine. The company has “continuity of life.”

4. Centralized Management

The management of a corporation is not concentrated in the stockholders. It’s the officers and directors that manage. The management is therefore “centralized” in someone other than the owners. The officers and directors do not have to be stockholders.  Although, if you sit on the IBM Board of Directors, you’ll get a nice bonus of IBM stock.

Forming an LLC – A Defective Corporation

When the LLC laws were first introduced into the US by Wyoming, the central question was how will this new type of company be taxed?  Wyoming petitioned the IRS for a ruling.  The IRS immediately came back and asked how an LLC was distinguished from a corporation.  The answer was an LLC can only have two of the four basic elements of a corporation.  Therefore, an LLC can be thought of as a defective corporation, because by law an LLC is restricted to only having two of the four corporate elements.

Most lawyers and internet sites don’t understand this restriction placed on an LLC.  You probably asked, “Do I want member managed or manager managed for my LLC?”  The answer came back, “It doesn’t matter – just pick one.”  It does matter, because you only get two picks.

You get to choose which two, but if your LLC is going to be “legal,” you can only choose two. Making the right choice can be pretty tricky.

First you want to choose limited liability as one element. Limited liability protects you from all the mistakes you make.  It’s the corporate shield – limited liability – so of course you will pick that one.  But, what to choose next?

If your LLC paperwork says you want it to be manager managed, then you have automatically picked centralized management. That’s all the picks you get.

These Are the Fine Points of the Law

If you have more than two of the elements, by law you’re not an LLC. If you don’t have all four, by law you’re not a corporation. That basically leaves you as a partnership and everybody is personally liable.

If the family in the story above had just used my LLC Wizard Course and been through Course 2, they would have known how to structure their LLC so that it had continuity of life. The LLC would have passed the basic legal test.

They could have done it themselves, and all of their protection would have been intact.

You can do it too. You’ll get an LLC that has a solid legal structure, plus you’ll get double asset protection and huge tax saving opportunities.

I hope by now you are saying…“OK, I’m convinced… I Can Do My Own LLC! You can start immediately and have your LLC within hours – no middleman.

Lee Phillips

P.S. You can also check out my FREE WEBINAR TRAINING – Maximizing Your LLC’s Money Making and Asset Protection Poten​​​​​​​tial