Creating an LLC Operating Agreement and LLC tax advantages

Limited Liability Company

Creating an LLC Operating Agreement

The LLC operating agreement allows you to coordinate your financial, operational, and working conditions with your partners. As with a partnership, the LLC lets you elect to run your company with your rules and not by the default rules set by New York State (which would come into affect if you did not have an operating agreement)

The operating agreement outlines the status of your LLC as an independent entity; this is particularly important in a one-person LLC, otherwise it looks like a partnership.

At first, creating the operating agreement might seem daunting; sometimes it is. However, most of the time entrepreneurs use a lawyer to construct an operating agreement. The operating agreement is one of the main (and sometimes only) reasons you might need a lawyer when you are starting your business.

Even though New York State does not require an operating agreement for your LLC, and you are rarely required by New York City, it is a good idea to create one. In the operating agreement, you create a set of rules for the procedures for your small business. The operating agreement usually includes:

• The allocation of profits and loses amongst members
• The management of the LLC
• The members' rights and responsibilities.
• The proportional interest that each member has in the business
• The proportional voting power of each member
• An outline for how to hold meetings and take votes.
• Provisions for the departure of one or more members from the LLC, such as buy/sell provisions. This becomes one of the most important sections in an operating agreement as it outlines how disputes will be resolved between partners.

Drafting an LLC agreement can be a complicated process, particularly if you have partners. We advise you to seek a lawyer's help. However, if cost is an issue, you can find templates of operating agreements that may satisfy your business needs. Check your local stationary store or in the legal section of a bookstore. You should make changes to these templates to suit your needs.

Distributive Shares

Usually the portion of profits and losses is allocated with the proportion of ownership in the LLC. If proportion of ownership to profits and losses differs, you have to follow your New York state rules for special allocations.

The IRS has very specific rules for special allocations in order to prevent owners from shifting income from the person with the highest tax bracket to the person with the lowest one. To test this, the IRS follows the "substantial economic effect" criteria, meaning that the special allocation is made as a factor of the owners' real economic situation. It is best to consult a tax professional when making special allocations.

Voting

Although most decisions in a LLC are informal, if the members of your LLC need to make a decision on a controversial issue, they can do so in a couple of ways. Usually the decision is based on the weight of each member's contribution.

Alternatively, each member may get one "per capita vote" (based on an individual's financial contribution to the LLC). Whichever method you choose, make sure it is specified in the operating agreement.

With the LLC the owners get all the profits of the business unless they choose to be taxed as a corporation. Any money the company makes is passed on to the owners. The LLC does not pay taxes on the profits but the owners who "actively take part" in the management of the business will need to pay self-employment taxes (Social Security & Medicare) and income tax. This can get confusing so you should speak with your acountant .

Ending an LLC

If there is no operating agreement, or unless your operating agreement states otherwise, a LLC terminates when one member leaves the organization. In this case, the LLC must complete the outstanding business responsibilities, pay all debts, and divide profits. If the remaining members want to continue with the business, then they have to set up another LLC.

A way to avoid this problem is by setting up a buy/sell agreement, spelling out what the procedures are if one of the members becomes disabled, retires, leaves the LLC, or dies.