Indiana Business Law Blog

The "Indiana Smoke Free Air Law," which was passed last year by the Indiana General Assembly and took effect on July 1, 2012, bans smoking in most Indiana businesses and nonprofit organizations. We thought the General Assembly might reconsider some of the details this year, but that hasn't happened. Based on our non-scientific observations, it seems that Indiana businesses and nonprofits have not been very diligent about implementing the law, particularly those regarding signs. So we think it's a good time to review the requirements, or at least some of them.

"Does the smoking ban affect my business?"

Smoking is now prohibited by law in "public places" and "places of employment," as well as the area within 8 feet of public entrances to either of them. "Public places" and "places of employment" sound as if they encompass a lot, and they do. A public place includes any enclosed area of a structure in which the public is permitted or invited, and a place of employment includes any enclosed area of a structure (excluding a private vehicle) that is a place of employment. Lest we forget, there's one other category -- smoking is also banned in government vehicles being used for governmental purposes.

There are some exceptions, but the bottom line is that the smoking ban affects most businesses and nonprofit organizations in Indiana.

"Okay, my office is covered. What do I have to do?"

• Not surprisingly, you must inform your employees and prospective employees that smoking is prohibited.
• You must post conspicuous signs that read "Smoking is Prohibited by State Law," or something to that effect. The law has a specific requirement that restaurants must have a conspicuous sign at each entrance informing the public that smoking is prohibited in the restaurant.
• You must also post signs at each entrance (logically, the sign should be outside or at least visible from the outside) stating "State Law Prohibits Smoking Within 8 Feet of this Entrance" or something similar.
• If someone smokes on the premises anyway, you must ask him or her to refrain, and if he or she refuses to stop, you must have him or her removed from the premises. (Note: Don't try to do it yourself! In the unlikely event it becomes necessary, call the police.)

"I own a bar. Does the smoking ban REALLY apply to my business?"

It depends. There are some exceptions to the smoking ban, and one of them is for bars and taverns, but you have to meet certain requirements. For example, you may not have any employees under 18, and you must exclude anyone else under 21. There are more exceptions for several other types of places of employment and public places, each subject to particular qualifications or additional requirements.

"Does the law apply to our nonprofit organization?"

Probably. There is an exception that covers some social clubs and fraternal organizations or lodges that are tax exempt under Internal Revenue Code Sections 501(c)(7), (c)(8), or (c)(10), and it's possible that some other types of nonprofits fit into an exception, but most nonprofits are subject to the smoking ban.

"I have a home office. Is smoking banned there, too?"

Again, it depends. The ban does not apply to a business located in the business owner's residence, but only if all the people who work there live in the residence. Let's assume that only you (the owner) and your spouse work in your office. In that case, you're allowed to smoke, but if you have any employees who don't live in your home, smoking is prohibited.

"Are there other exceptions?"

Yes. For a complete list see Ind. Code 7.1-5-1-5.

"My facility falls within an exception to the smoking ban, so I'm home free. Right?"

Well, not entirely. There are some other requirements that apply to public places and places of employment in which smoking is permitted. Here's an interesting one -- you have to post signs that state "WARNING: Smoking is allowed in this establishment." You must also certify to the Indiana Alcohol and Tobacco Commission that your bar qualifies for the exception.

Moreover, even if most of your facility or building is exempted from the ban, smoking is prohibited in halls, elevators, and common areas where people under 18 are permitted or in rooms intended for use by people under 18.

And don't forget that even if the state law does not ban smoking in your business, it may be prohibited by local no-smoking laws -- such as the Indianapolis Ordinance -- which are allowed to be more restrictive than the state law.

Other resources

NOTE: This is not a comprehensive analysis of the Indiana Smoke Free Air Law. There are other exceptions and other requirements that may apply to your business or nonprofit (even if it is exempt from the ban itself) that we have not discussed. Here are some other resources:

• The full text of the statute can be found at Ind. Code 7.1-5-1.


• The Indiana State Excise Police have published a list of frequently asked questions.


• And signs that comply with the state law are readily available from a number of suppliers.

Continue reading "Indiana Smoking Ban" »

UPDATE, February 19, 2013.
Yesterday, the House Judiciary Committee amended HB1394 to remove the language discussed in this blog post -- the changes to IC 23-18-6-7 that would have expressly provided that a charging order is the only right that the creditor of an LLC member has with respect to the LLC. It appears that Indiana will remain in the fourth category of states listed in the article -- those in which there is no reverse veil piercing for multi-member LLCs, with the issue remaining unsettled with respect to single member LLCs. The most recent version of the bill is available here.

In my last post, I discussed HB 1394, a bill pending in the Indiana General Assembly that would make several amendments to the statute that governs Indiana limited liability companies. One of the most important changes is to strengthen the so-called "charging order" protection, which I'll describe shortly after a brief review of some attributes of LLCs and corporations.

Recall that corporations and LLCs both have liability shields that protect the owners of the company (for a corporation, the shareholders; for a limited liability company, the members) from being personally liable for the company's obligations. That liability shield (whether it's for a corporation or LLC) is sometimes called a corporate veil, and in some circumstances courts will ignore the shield, or pierce the corporate veil, to allow creditors of the business to reach the personal assets of the owners. I've previously discussed precautions that LLC members can take to keep that from happening.

When a court allows a creditor of the business to reach the personal assets of the owners, it's sometimes called "inside-out veil piercing," which implies there might be something else called "outside-in veil piercing." And there is.

Consider what happens when a shareholder of a corporation owes money to a creditor. The shareholder's stock is just like any other asset, like a bank account, a house, or a car. And just like any other asset (well, most other assets), the stock is subject to foreclosure, which effectively means the creditor takes over ownership. The creditor, now the new shareholder, receives all the rights associated with the stock, including the economic rights (i.e., the right to receive dividends, if there are any) and the non-economic rights (including the right to vote in elections of the board of directors). That's called "outside-in veil piercing" or sometimes "reverse veil piercing." If the creditor takes over enough shares of stock, he or she can gain control of the company. Even if the creditor does not gain control of the company, the other shareholders may suddenly find themselves co-owners with someone they don't even know, maybe even with someone they despise. For large, publicly traded companies with millions of shareholders, that's no big deal. For family businesses or other businesses with only a few shareholders, it can be a very big deal.

The area of reverse veil piercing is one in which LLCs differ tremendously from corporations, at least in some states, and it is one of the reasons that I advise clients to set up LLC's far more often than I advise them to set up corporations. When it comes to the rights of a member's creditors, many states, including Indiana, treat the member's economic rights and non-economic rights separately. For example, IC 23-18-6-7 allows a court to issue an order requiring a limited liability company to pay to a member's creditors anything that the LLC would otherwise be required to pay to the member. That's called a charging order, and it's something like an order for the garnishment of wages, applied to a member's right to receive LLC distributions.

The question is whether a charging order is the only remedy a creditor has against the member's rights. If so, there is no reverse veil piercing, and a member's creditors cannot take over control of the business or gain a seat at the table with the other members. I believe there are currently five categories of states:

1. Those in which reverse veil piercing is not allowed for LLCs.
2. Those in which reverse veil piercing is allowed for single-member LLCs but not for multi-member LLCs.
3. Those in which reverse veil piercing is allowed for both single-member LLCs and multi-member LLCs (essentially treating LLCs the same as corporations).
4. Those in which there is no reverse veil piercing for multi-member LLCs but for which the law is unresolved for single-member LLCs.
5. Those in which the law is unresolved for reverse veil piercing both single-member and multi-member LLCs.

Until fairly recently, Indiana was in the fourth group of states. As I've discussed elsewhere, a 2005 decision of the Indiana Court of Appeals, Brant v. Krilich, held that there is no reverse veil-piercing for multi-member LLCs, but apparently leaving the question open for single-member LLCs.

HB 1394 would add a provision to IC 23-18-6-7 expressly stating that a charging order is the exclusive remedy for a judgment creditor of a member and that the creditor has no right to foreclose on the member's interest. Because the bill makes no distinction between single-member and multi-member LLCs, it appears that HB 1394 would place Indiana in the first category of states -- those for which reverse veil piercing is not allowed for either single-member or multi-member LLCs.

Continue reading "Proposed Changes to Indiana LLC Statute Part 2: Charging Order Protection" »

Statutes governing limited liability companies, or LLCs, vary considerably from state to state. In our opinion, Indiana's statute is already among the best in the country, and a bill introduced in the 2013 session of the Indiana General Assembly proposes several changes that would make it even better for small business owners, particularly family-owned businesses. Among other things, HB 1394, introduced by Rep. Greg Steuerwald (R Avon) would:

• Eliminate the possibility that a creditor of a member can take over the member's voting rights


• Allow a membership interest to be held in joint tenancy with the right of survivorship


• Allow a membership interest to be designated as "transfer on death" property


• Expressly provide for LLC officers

Later posts will discuss these proposed changes in more detail, including a few suggestions for possible revisions to the bill that would make it even better. In the meantime, however, small business owners in Indiana may want to contact their state representatives and senators urging them to support HB 1394.

Continue reading "Proposed Changes to Indiana LLC Statute" »

The Indiana Secretary of State has issued a warning about a deceptive letter being received by some Indiana businesses. The letter asks for a fee -- typically $125 or $150 -- to cover the processing of the minutes of a corporation's annual meeting. It is designed to appear as if it is from a state agency, the "Indiana Corporate Compliance Business Division," and it includes a citation to a fictitious law. In fact, it is not from a state agency, and there is no requirement to pay any such fees to the state.

If you receive a letter like the one described above, ignore it. If you have already responded to a letter like this, you may contact the Business Services Division of the Indiana Secretary of State's office at (317) 232-6576.

However, if you receive a letter from the Indiana Secretary of State's office informing you that a business entity report is due by the end of the following month, DO NOT IGNORE IT!

Indiana business corporations and limited liability companies are required to submit a business entity report every two years during the month of the anniversary of the filing of the articles of incorporation or articles of organization. For example, if your articles of incorporation or articles of organization were filed in April of an even-numbered year, a business entity report is due in April of every even-numbered year.

Indiana nonprofit corporations are required to file business entity reports (even though a nonprofit corporation is not usually considered to be a "business") every year in the month of the anniversary of the filing of the articles of incorporation. If the articles of incorporation of your nonprofit were filed in August, a business entity report is due every August.

Business entity reports may be filed on paper or online. The filing fee for business corporations and limited liability companies is $30, and the fee for nonprofits is $10. In both instances, modest discounts are given for filing online.

The Secretary of State's office sends out reminder notices near the end of the month before your business entity report is due, but do not rely on those letters as your only reminder. Because the reports are due even if you do not receive the letter, you should make sure the report is placed on your compliance calendar.

If your organization does not file its business entity reports on time, it is subject to administrative dissolution by the Secretary of State. If that happens, it is possible to have your corporation or LLC reinstated, but the process can be time consuming. It's far better to stay in compliance to begin with.

Continue reading "Letter About Annual Minutes is a Scam -- but Notice About Business Entity Reports is Not!" »

Businesses and nonprofit organizations that have recently hired unemployed veterans and those that do so before 2013 may be eligible for a tax credit of as much as $9,600 for each unemployed veteran hired by a business or as much as $6,240 for each unemployed veteran hired by a qualified tax exempt organization. Qualifying businesses will receive a credit against income tax, and qualifying tax exempt organizations will receive a credit against the employer's share of Social Security tax.

The tax credit is a result of the bipartisan VOW to Hire Heroes Act of 2011, unanimously passed by both houses of Congress and signed by the President on November 21, 2011, which expanded the Work Opportunity Tax Credit (or "WOTC") to include certain classes of unemployed veterans. The amount of credit available depends on the length of time the veteran was unemployed before being hired, the number of hours the veteran works, the amount the veteran is paid in the first year of employment, and whether the veteran has a service-related disability.

Critical Deadlines

Businesses and tax exempt organizations that wish to take advantage of the tax credit need to be aware of two critical deadlines. You will not get the tax credit if you fail to meet either one:

• First, the expanded tax credit expires at the end of the year. The veteran must start work on or before December 31, 2012.
  


• Second, the employer must file certain forms within 28 days after the veteran starts work. (Other rules were in place for veterans hired before May 22, 2012.) Different forms are required for businesses and for tax exempt organizations. The process of for claiming the credit, including a list of the required forms, is summarized here.
  

The IRS has provided several other sources of information on the WOTC for veterans, including a list of frequently asked questions and a detailed description of the WOTC. You should also consult your tax advisor.

Continue reading "Hiring soon? Consider an Unemployed Veteran!" »

The Internal Revenue Service has announced the following standard mileage rates used to calculate income tax deductions for business travel expenses and for travel expenses incurred while serving charitable organizations.

• Business, $0.565 per mile
• Charitable service, $0.14 per mile

These rates, which are one cent per mile higher than the standard rates for 2012, take effect on January 1, 2013.

Continue reading "IRS Standard Mileage Rates Will Increase in 2013" »

As a mild spring finally melts into the heat of summer, perhaps you'll soon take a moment to enjoy a small cup of lemonade from a small business on a sidewalk near you. After all it is National Small Business Week.

But while you enjoy your refreshment, consider taking the moment to pay homage to small business and ponder the following questions: What is so unique about a small business? What is it about some small businesses that set them above the rest? When it comes to the legal aspects of business, how can business owners be active rather than passive and what are the payoffs? What are the legal considerations inherent to owning and operating a small business? What about a grown-up's small business can ensure it is any less transient than the venture which sold you your beverage?

If you are a prospective or current small business owner, you likely know first-hand the value of answering such questions earlier rather than later. During the creation of a company and after it is formed, the legal concerns which come into play should be dealt with head-on. Like the rest of a savvy entrepreneur's endeavors, the legal tasks of business organization and transactions, when accomplished both properly and skillfully, are their own reward.

Without a doubt, small businesses are the workhorse of the U.S. economy, representing 99.7 percent of all employer firms and generating 65 percent of net new jobs over the past 17 years (Source of data: U.S. Small Business Administration). The benefits small businesses render to local economies are no joke. An organization we support, The 3/50 Project, recognizes this reality and is setting out to "save the brick and mortars our nation is built on" in a way that is turning heads. No matter what your relation may be to the wonders of small business ownership, consider celebrating the week by exposing yourself to the simple mission of The 3/50 Project and learning in under a minute how you can very practically help to "save your local economy."

Continue reading "Happy "National Small Business Week!"" »

In my last entry, I discussed the corporate veil and the protection it provides to individuals who own LLCs or have stock in corporations. Corporate veil piercing only becomes an issue when the LLC or corporation does not have enough financial assets to pay a creditor and that creditor wants to find another way to satisfy that debt. To that end, a creditor may try to persuade a court that the business's corporate veil should be pierced, allowing the creditor access to the owner's personal assets. Most of the time, it won't work, but in some circumstances it will. Here are the factors that tend to justify piercing the corporate veil.

• The business is undercapitalized


• The owners have made fraudulent representations


• The owners have used the business to promote fraud, injustice or illegal activities


• The assets of the business have been used to pay the obligations of the owners


• The owners have commingled their own assets and affairs with those of the business


• Business or corporate records are absent


• The owners have failed to observe required corporate formalities


• The owners have otherwise ignored, controlled, or manipulated the corporate entity

Before I dive into the details of each factor, it's important to note that Indiana courts consider veil piercing to be extremely fact sensitive. In other words, judges look at these issues and base their decisions on the very specific facts of each particular case. In one case, the court may not permit the veil to be pierced despite the presence of several factors. In another case, the presence of even one factor may justify piercing the veil. That means that a prudent business owner needs to keep all of them in mind. That said, let's get on with it.

The first factor is undercapitalization, which has been defined by the courts as "capitalization very small in relation to the nature of the business of the corporation and the risks attendant to such business." Of course, almost anytime a creditor tries to piece the corporate veil, the business is, in one sense, undercapitalized because if the business had enough money to pay the creditor, there would be no need to pierce the veil. So the question is not whether the business is undercapitalized when the veil-piercing lawsuit is filed, but whether it was properly capitalized to begin with. The policy underlying this factor may be the notion that business owners should place at least a reasonable amount of capital at risk. As far as these factors go, undercapitalization is a fairly weak one. Taken alone, it is seldom if ever enough to justify piercing the corporate veil. Often, it will be raised as a minor factor where other, stronger considerations are present. Even so, one way small business owners can protect themselves is to make sure the business is not undercapitalized.

The next two factors are related, and they play a significant role in many veil-piercing cases. Both of them deal with fraud. Indiana courts do not have much sympathy for individuals who use a LLC or corporation to perpetrate fraud and it is highly likely they will pierce the corporate veil if there is evidence of fraudulent business activities. Fraud can include misrepresenting facts about the company to customers or other third parties. For instance, making statements you know are false or otherwise misleading someone to induce them to enter into an agreement with your business could be considered fraudulent misrepresentation.

Sometimes however, what is legitimate in one situation is fraudulent in another. Consider two LLCs that are have a common owner. In most circumstances, if the owner wants to move assets from one of the LLCs to the other, it's perfectly legitimate to do so, assuming the owner keeps the books straight and pays any taxes that might be triggered by the transfer. Now imagine that the owner realizes that one of the LLC's is about to be sued and decides to transfer all the assets owned by that LLC into the other. That attempt to use the LLCs to hide assets from creditors can be (and has been) deemed fraudulent and used as a reason to pierce the corporate veil.

So the second and third ways business owners can avoid becoming personally liable for the obligations of the business are to avoid making fraudulent representations and to avoid using the business for fraudulent, unjust, or illegal activities. We'll cover the other factors in the next entry in this series.

Continue reading "Veil Piercing Part TWO: A few ways to protect your business from having its corporate veil pierced in Indiana" »

This is the first of a series of occasional blog entries dedicated to explaining how Indiana courts deal with the "corporate veil" and "veil piercing" and what small business owners can do to protect themselves from being personally liable for the debts and obligations of the business.

"Corporate veil" is a phrase used to describe the liability shield between the owner of a company and the company itself, and, as the name implies, it originated in the context of corporations. Without the corporate veil, corporations could not raise capital by selling stock to investors, and modern stock exchanges could not exist. Imagine that you buy $10,000 worth of a corporation's stock through an online stock broker, maybe the one with those talking baby commercials, hoping to collect some small dividends for a few years, then sell the shares at a nice profit. Now imagine that one day an envelope appears in your mailbox, but instead of a quarterly dividend check, it contains a letter from the company's creditors saying that the company does not have enough money to pay its bills and that, for your convenience,they have enclosed an envelope that you may use to mail in payment of your share of the corporation's debt, which comes to $75,633. And 27 cents. No personal checks, and the post office will not deliver mail without a stamp.

I suspect that would be the last stock you'd ever buy.

The reason that doesn't happen is the corporate veil. Even if a corporation's stock becomes worthless, the shareholder's loss is limited to the money he or she invested in the stock. The shareholder's other assets -- the house, the car, the checking account, the baseball card collection, and the family dog -- are safe from the corporation's creditors. And that's true not only for the shareholders of large, publicly traded corporations; it's also true for the owners of the smallest incorporated businesses. Furthermore, as a previous blog entry explained, the same type of corporate veil prevents the creditors of a limited liability company from reaching the assets of the LLC's members.

At least, that's the way it works most of the time. However, sometimes, in certain circumstances, a court may allow the creditors of the LLC or corporation to reach through the corporate veil and to collect directly from the business owners. That's called "piercing the corporate veil," and one time it can happen is when the owner has used the company to perpetrate fraud. A future entry will discuss in more detail the circumstances that can lead to veil piercing.

But before we get there, business owners need to remember one other limitation of the corporate veil -- it does not protect them from their own liability. That commonly arises in one of two different ways. First, imagine of a group of engineers who start their own engineering firm and organize it as a limited liability company. If one of the owner-engineers negligently makes a mistake on a design project, that particular owner-engineer can be held liable -- not because he or she is an owner of the LLC, but because he or she is the engineer who made the mistake. In addtion, the LLC will also be liable (at least in most cases), but the personal assets of the other owner-engineers will be protected by the corporate veil. (Hopefully, the owners will have heeded my earlier advice to get a good insurance broker, and the LLC will have an errors-and-omissions policy to cover the liabilty of both the LLC and the negligent engineer.)

The second common way that a member of a limited liability company becomes liable for the obligations of the LLC is when the member contractually assumes the obligation. For example, banks and other lenders often will not extend a loan to a small LLC unless the members sign a personal guaranty that obligates them to repay the money if the LLC doesn't. In those situations, the corporate veil does not prevent the lender from reaching the personal assets of a member-guarantor.

Watch for my next entry on this topic to learn about what you can do to protect your company from having its corporate veil pierced. (Sounds painful, doesn't it?)

Continue reading "Veil Piercing Part ONE: What is the "corporate veil" and can it be "pierced" under Indiana law?" »

With summer vacation approaching, and with the job market being what it is, small business owners may be approached by college or high school students offering to work as undpaid interns. At first, that may seem like a great idea -- the business gets free help for the summer, maybe to fill in for vacationing employees, and the student gains experience and a chance to build a resume. Sounds like a win-win situation, right?

Well, maybe not. In fact, the situation could place the business on the receiving end of a lawsuit or government enforcement action. The problem is that most interns at for-profit businesses qualify as employees under the Fair Labor Standards Act, or FSLA, and must be paid at least minimum wage and overtime compensation if they work more than 40 hours in a week). In other words, you can't avoid paying minimum wage by paying nothing.

However, there is a very narrow exception for interns that qualify as "trainees." Last April, the Department of Labor published Fact Sheet #71, listing the criteria for determining whether an intern is a trainee. If an internship has all six of the following characteristics, the intern is not classified as an employee under the FLSA.

1. The intern receives training similar to the training he or she would receive in an educational environment. Preferably, the program should be centered on a classroom or academic setting, not on the business's operations. Ideally, the program should be associated with an educational institution that gives the intern academic credit for the program.
2. The internship is for the benefit of the intern. If the intern's activities are primarily for the benefit of the employer (see item 5), the fact that the intern also acquires useful job skills is not sufficient to classify him or her as a trainee. Ideally, the intern will learn skills that are useful to other employers, not just to the business sponsoring the program.
3. The intern does not displace employees. Instead, existing employees closely supervise the intern's work. If the business uses an internship to supplement its staff or to fill in for employees who are absent or on vacation, the intern is an employee, not a trainee.
4. The business does not derive an immediate advantage from the intern's work; in fact, the internship may even impede the business's operations. Although it can probably be argued that the business always derives some amount of benefit from the internship program, the internship must be primarily and predominantly for the benefit of the intern, not the benefit of the business.
5. The business will not necessarily employ the intern when the internship is finished. If the business uses the internship as a trial period for prospective employees, the intern is probably an employee, not a trainee.
6. The intern and the business understand that the intern will not be paid during the internship.

Given those criteria, it's easy to understand why a Department of Labor official told The New York Times last year that most unpaid internships with for-profit businesses are not legal. (The story is different, however, for internships with governmental agencies and nonprofit organizations. That's the topic of a future blog post.)

When the Department of Labor released Fact Sheet #71 last April, some news sources and bloggers described the six criteria listed above as "new regulations." In fact, the criteria are are not new, and they are not regulations. They originated in 1947 with Walling v. Portland Terminal Co., a decision of the U.S. Supreme Court dealing with a training program for prospective railyard brakemen. Since then the criteria have been applied, explained, and refined by lower courts and the Department of Labor. Rather than a new regulation, Fact Sheet #71 can be seen as the Department's warning shot across the bow of businesses that use "unpaid interns" as a source of free labor.

A note of caution about the use of these criteria. If the internship satisfies all six of the above criteria, the intern is deemed to be a trainee and not an employee, but only for determining whether the Fair Labor Standards Act applies. That's only one of many contexts in which the categorization of a person as an "employee" carries legal significance, and different criteria apply in each of those different contexts. Even though a trainee is not an employee for FSLA purposes, he or she may be an employee for other purposes, including the relevant state labor laws.

Continue reading "Is it legal for a business to use unpaid interns?" »

[This is the last of a seven-part series of posts discussing the characteristics of limited liability companies and comparing them to the characteristics of corporations, general partnerships, and sole proprietorships. Here's the entire list.

Part 1. Background on sole proprietorships.
Part 2. Background on partnerships.
Part 3. Background on corporations.
Part 4. LLCs are distinct legal entities, separate from their owners.
Part 5. A limited liability company's owners are not liable for the LLC's obligations.
Part 6. Options for an LLC's management structure.
Part 7. Options for an LLC's tax treatment.]

In prior posts, I've discussed several characteristics of LLCs. First, like corporations, LLCs are entities separate from their owners. Second, also like corporations, the owners are not liable for the obliigations of the LLC. Third, they offer choices of management structures: They can be managed directly by the owners, like sole proprietorships and many partnerships, or they can be managed by others who are selected by the owners, in much the same way that shareholders of a corporation elect directors to run the business. This last post of the series looks at the tax characteristics of LLCs.

Interestingly, LLCs do not have a specific category in the Internal Revenue Code or the Tax Regulations. Instead, their tax treatment is governed by the so-called "check-the-box regulation." It provides that the LLC may elect to be treated in one of several ways, and the choices depend on whether the LLC has one member or more than one member.

The default status for a single-member LLC is that it is a "disregarded entity" in that all the income and expenses go directly on the member's personal tax return, just like a sole proprietorship. The LLC itself doesn't even have to file a tax return. The default status for a multi-member LLC is to be taxed as if it were a partnership. Alternatively, either a single-member LLC or a multi-member LLC can elect to be taxed as if it were a corporation, either as a Subchapter C corporation or, if the LLC meets certain criteria, as a Subchapter S corporation. To decide which is the best tax strategy for your LLC, you should consult both your lawyer and your accountant.

Continue reading "Just what IS a limited liability company? Part 7. It's a bundle of tax choices." »

[This is the sixth post in a seven-part series discussing the characteristics of limited liability companies and comparing them to the characteristics of corporations, general partnerships, and sole proprietorships. Here's the entire list.

Part 1. Background on sole proprietorships.
Part 2. Background on partnerships.
Part 3. Background on corporations.
Part 4. LLCs are distinct legal entities, separate from their owners.
Part 5. A limited liability company's owners are not liable for the LLC's obligations.
Part 6. Options for an LLC's management structure.
Part 7. Options for an LLC's tax treatment.]

Previous posts discussed the management structures of the three classic business entities that we're using as a framework for discussing limited liability companies and, in particular, exactly who is responsible for running the business day-to-day.

Sole Proprietorships. Remember Drucker's General Store, the example I used to illustrate sole proprietorships? Sam Drucker ran his own store on a day-to-day basis. In fact, I'm not sure Sam even had any employees. That's the prototypical management structure for a sole proprietorship -- the proprietor himself or herself runs the business on a day-to-day basis.

Corporations. Once again, corporations are at the opposite end of the spectrum from sole proprietorships. As discussed earlier,the owners of a corporation (i.e., the shareholders), have no role in the day-to-day operation of the business. Instead, their role is limited to electing a board of directors who, in turn, usually delegate responsibility to officers and employees of the company. Of course, in a closely held company, it's very common for the owners, acting as shareholders, to elect themselves as directors and then to appoint themselves as officers.

General Partnerships. The management structure of general partnerships varies a bit more, but usually the day to day affairs are managed by the partners themselves -- by all of the partners, or by a management committee composed of partners, or by a single managing partner.

Limited Liability Companies. Fundamentally, there are two different ways limited liability companies can be managed -- by the members themselves or by one or more managers, who are appointed by the members. In other words, a limited liability company has the flexibility to be managed like a sole proprietorship and many partnerships are managed -- by the owners of the business themselves. However, it's also possible for the owners to be relatively far removed from the day-to-day operation of the company, with a role largely restricted to appointing one or more managers to operate the LLC. Note, however, that the members of a manager-managed LLC are free to name one or more of their own as manager(s).

Even a single-member LLC has the same choices of management by the members or management by managers. A few days ago, in explaining why a single-member LLC needs an operating agreement, I touched on some of the reasons that the sole owner of a limited liability company might choose to make their LLC manager-managed.

So one of the advantages of a limited liability company is that it offers choices for management structure. Next we'll see that a limited liability company offers choices for tax treatment as well.

Continue reading "Just what IS a limited liability company? Part 6. It offers choices of management structure." »

Under current Indiana law, you can easily start up a limited liability company (LLC) with a credit card and an internet connection. After making a quick trip to the Indiana Secretary of State's website, submitting articles of organization, and paying a fee you could have your very own LLC in about fifteen minutes. But what about creating an operating agreement for your LLC? Nothing about that process requires -- or even mentions -- an operating agreement. Strictly speaking, it's not legally required, and if the LLC has only one member, an operating agreement may even seem pointless. Nonetheless, I advise all my clients with LLCs -- even single-member LLCs -- to have operating agreements.

The reason the Indiana Business Flexibility Act does not require an operating agreement is that it contains default rules that govern the LLC if there is no operating agreement (or if there is an operating agreement but it doesn't address every issue). However, those default rules may or may not be what you want. Having an operating agreement created specifically for the needs and goals of your single-member LLC can help sort out which aspects of the Indiana Business Flexibility Act will apply to your LLC and which will be overridden.

A particular reason that I think single-member LLCs should have an operating agreement flows from the fact that I think most single-member LLCs (at least those owned by individuals rather than by another business entity) should be manager-managed rather than member-managed. Imagine you are the sole member of your own LLC, and it is member-managed. That means that you, and only you, have the authority to take actions on behalf of the LLC. Now imagine that you are in a serious accident and unable to manage your business for an extended period of time. There is no one who can step into your shoes and run the business in your absence.

However, imagine that you set the business up as a manager-managed LLC. You can name yourself as the manager and some other trusted person, such as your spouse, as the assistant manager who has the authority to step in and run the LLC if you are not able to. To do that, you'll need an operating agreement that describes the authority of the other person to run the business when you can't.

It's also likely that third parties, such as banks and the IRS, will want to know various details about how the LLC is organized. An operating agreement includes information like who has the authority to sign contracts for the LLC, the LLC's tax status, and other legally meaningful information. Being able to hand a third party a single document that clearly lays out all of the legally significant details about the LLC can save a lot of time and confusion for the member and the entities the LLC does business with.

Continue reading "Why should a single-member LLC have an operating agreement?" »

[This is the fifth post in a seven-part series discussing the characteristics of limited liability companies and comparing them to the characteristics of corporations, general partnerships, and sole proprietorships. Here's the entire list.

Part 1. Background on sole proprietorships.
Part 2. Background on partnerships.
Part 3. Background on corporations.
Part 4. LLCs are distinct legal entities, separate from their owners.
Part 5. A limited liability company's owners are not liable for the LLC's obligations.
Part 6. Options for an LLC's management structure.
Part 7. Options for an LLC's tax treatment.]

The last entry in this series explained that a limited liability company has its own legal identity, separate from its members. A related concept is that a limited liability company has a liability shield, sometimes called a corporate veil, between itself and its members. That means that the members of a limited liability company are not liable for the debts or obligations of the LLC itself, just as the shareholders of a corporation are not liable for the debts or obligations of the corporation itself.

To see how that works, let's imagine that you and two of your good friends, Jack and Jill, decide to buy a bicycle shop. You consult an attorney, and he recommends that you create a limited liability company to buy the shop. He writes an operating agreement for you, which all three of you sign, files articles of organization in the Indiana Secretary of State's office, and takes care of other details such as obtaining an Employer Identification Number . At that point you are the proud owners of a limited liability company Three Good Friends, LLC . (By the way, there is no such LLC in Indiana. I know that because I ran a search on the Secretary of State's website.) The purpose of the LLC is to buy and run a bicycle shop. To raise the money, you and Jill each drain your savings accounts, and Jack mortgages his house to the hilt. All three of you put the money (called your initial capital contributions) into the LLC, and with that money the LLC buys a bicycle shop, which you rename as Three Good Friends Bicycle Emporium. The LLC's lawyer files a certificate of assumed business name showing that Three Good Friends, LLC is now doing business as Three Good Friends Bicycle Emporium.

While you're working in the shop one afternoon, a delivery truck arrives. A LARGE delivery truck. The driver comes in and asks where you'd like to put the 700 bicycles you ordered. (I don't know if a single truck can actually hold 700 bicycles, but cut me some slack and go with me on this.) You tell him there must be some mistake because you ordered only 7 bicycles. After a frantic search through your computer files, you realize that a mistake was indeed made -- and that you're the one who made it. You really did order 700 bicycles. And they're expensive bicycles. VERY expensive. You make a few phone calls and find out that the bicycles cannot be returned and that the shop will have to pay for them. You also know that there's not nearly enough money in the LLC's bank account to pay for the bicycles.

You tell Jack and Jill what happened, expecting them to be furious -- and Jack is. As Jack often does, he imagines the worst. He says that the bicycle manufacturer is going to sue not only the shop but all three of you. He worries that not only will the three of you lose the business, but that he'll lose his house, which he mortgaged to the hilt to come up with the money for the business. Jill, being her characteristically calm self, tells Jack not to worry. The reason that they set up a limited liability company was so that none of the three good friends can be held liable for the debts of Three Good Friends Bicycle Emporium. She tells Jack that even if the LLC goes bankrupt, his house is safe from the bicycle manufacturer. Is Jill right?

Continue reading "Just what IS a limited liability company? Part 5. It has a liability shield." »

[This is the third post in a seven-part series discussing the characteristics of limited liability companies and comparing them to the characteristics of corporations, general partnerships, and sole proprietorships. Here's the entire list.

Part 1. Background on sole proprietorships.
Part 2. Background on partnerships.
Part 3. Background on corporations.
Part 4. LLCs are distinct legal entities, separate from their owners.
Part 5. A limited liability company's owners are not liable for the LLC's obligations.
Part 6. Options for an LLC's management structure.
Part 7. Options for an LLC's tax treatment.]

Let's get back to our trek toward a discussion of the basics of limited liability companies. The first two types of business structures we've looked at -- sole proprietorships and partnerships -- have two significant features in common. First, the owner or owners are liable for the obligations of the business. Second, the business itself does not pay taxes. Instead, the income and other tax items are "passed through" to the owner or owners, who pay tax on the income. Things change with corporations, the third type of business structure.

Although corporations are not as old as sole proprietorships or partnerships, business organizations with at least some of the characteristics of corporations have been around for centuries. For example, the oldest corporation in North America, Hudson's Bay Company, was incorporated in 1670.

Perhaps the most important feature of a corporation is that the owners of the corporation -- called stockholders or shareholders -- are NOT liable for the obligations of the business. And that's very good news for people who owned stock in Lehman Brothers, which melted down into the largest bankruptcy in American history. Or, going back a little further to previous record holders, people who owned stock in Enron and Worldcom. Even though the people who owned stock in those corporations may have lost everything they invested, they were not liable to the corporations' creditors, and they did not get pulled into the corporate bankruptcies. That protection against shareholders being held liable for the corporation's obligations is sometimes called a liability shield or a corporate veil, and it doesn't exist for sole proprietorships or general partnerships.

Continue reading "Just what IS a limited liability company? Part 3. It's not a corporation." »