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THE

FERNANDES
LAW FIRM

I want to provide you with some guidelines that are important in realizing the benefits a
limited liability company since doing business in the form of an LLC provides limited liability
for all members and advantageous partnership treatment for federal income tax purposes. This
particular combination of benefits is not available with any other form of business entity, and
you will need to follow certain guidelines to be certain that the benefits remain available.
1.

Separate Entity

In order to obtain limited liability for members, it is critical that an LLC be operated as a
business entity that is separate from its members. If an LLC is operated as an alter ego of the
members, creditors of the LLC may be able to recover their claims from the members rather than
being limited to recovery from the LLC itself.
a. Adequate Assets

In order to function as a separate entity, an LLC needs sufficient assets to operate its
business. At the time your LLC is organized the company will need enough capital to have a
reasonable chance of being successful. Ownership of the cash or assets needs to be transferred to
the LLC; nor should substantial distributions of cash or assets should be made to members until
your LLC has accumulated sufficient profits to fund the distributions.
Applicable state law prohibits an LLC from making any distribution that would cause the
LLCs liabilities to exceed its assets or would prevent the LLC from paying its obligations as
they become due in the ordinary course of business. If distributions are made in violation of
these insolvency restrictions, the members receiving the distributions may be required to repay
the LLC at the behest of other members or the LLCs creditors.
b. Separate Assets

As a separate entity, your LLC needs to have its own assets. The LLC must have a
separate bank account and should hold title to its assets in its own name. Under no
circumstances should the personal funds, assets, or accounts of members be mixed with those of
the LLC. Similarly, LLC funds should never be used to pay personal expenses of members, to
make personal investments for members, or for any other purposes not related to the LLCs
business.
Cash or other assets should be transferred to members by the LLC in only three
situationsto make distributions permitted under the terms of the operating agreement and the

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applicable state LLC statute, to reimburse members for reasonable expenses incurred on behalf
of the LLC, and pay reasonable compensation for services performed by members for the LLC,
the amount of which has been agreed upon in advance. Since reimbursement of expenses and
payment of compensation can be the equivalent of a distribution, particularly if the expenses or
compensation are unreasonable in nature or amount, the insolvency restrictions that are discussed
above can apply, and these restrictions need to be considered whenever cash or assets are
transferred to members.
If assets owned by a member of your LLC are used by the LLC, appropriate
arrangements should be made and documented. For example, if a member leases an office,
production facility, or warehouse to the LLC, there should be a written lease agreement, and the
terms should be fair to the LLC. Its a good idea to document loans from members to the LLC
with promissory notes and to provide for a reasonable rate of interest that is actually paid by the
LLC. In the absence of these precautions, the LLC and its members may appear to be one and
the same individual or entity, which jeopardizes the members limited liability protections.
c. Separate Operations

An LLC must be operated as an entity that is separate from its members. The business of
your LLC should be conducted in the name of the LLC, and the LLCs name should be used on
all agreements, contracts, leases, orders, and other arrangements entered into by the LLC. This
name should also be used on all products, signs, advertisements, correspondence, business cards,
telephone directory listings, and similar items. The LLC will need to obtain and carry its own
insurance and to file its own income and employment tax returns ask for assistance with setting
up the books and records of the LLC from your accountant.
An LLC can only act through its members. But when one of you is acting for your LLC,
remember that you are acting an agent of the LLC and not in your individual capacity. For
example, members should sign all documents on behalf of the LLC as follows: [Name of LLC]
by [Name of Member], Member. This makes is clear that the member is signing in a
representative capacity and is not accepting personal liability for the performance of the
obligations spelled out in the agreement.

2.

Income Tax Matters

The LLC will be treated as a partnership for federal income tax purposes unless you elect
to be taxed as a corporation. Electing to be taxed as a corporation can involve very serious
income tax consequences that may be disadvantageous to you either now or in the future. There
can be adverse tax consequences even if your LLC elects to be taxed as an S corporation.
Consequently, you should not make the election to be taxed as corporation without carefully
considering the ramifications with your accountant.
There is generally far less tax cost associated with converting a partnership to a

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corporation than there is in converting a corporation to a partnership. When in doubt, its better
to start with partnership classification rather than making an election to be taxed as a corporation.
A partnership must file a federal information income tax return each year. Any income
or loss shown on this return passes through to the members and must be reported on their
individual income tax returns. Your LLC may also be required to file income tax returns in
states and localities in which it operates. You should consult with your certified public
accountant regarding compliance with applicable income and other tax filing requirements.
Although the LLC will be taxed as a partnership, it should not be held out to the public as
a partnership. An LLC provides limited liability for all members, and a partnership does not. If
members of an LLC identify themselves as partners when dealing with third parties, there is a
risk that creditors of the LLC will be able to assert their claims against the members individually.
3.

Operating Agreement

The operating agreement LLC provides a road map for conducting LLC operations in a
manner that preserves the benefits of this form of doing business. You should refer to the
operating agreement periodically to be certain that your LLCs operations are being conducted
properly.
Among other things, you should hold a member meeting whenever a major decision
requiring the consent of the members is to be made. These decisions include changing the nature
of the business of the LLC, making optional distributions to members, selling all or a substantial
part of the assets of the LLC, entering into transactions involving a conflict of interest with a
member, admitting a new member, and continuing the LLC following the death, incapacity,
withdrawal, expulsion, bankruptcy, or dissolution of a member.
A permanent written record should be made of all member meetings indicating who was
present at the meeting, what action was taken at the meeting, and the number of members voting
in favor of or against each action taken. The record of meetings should be kept at the principal
office of the LLC. The operating agreement contains a list of the other types of records and
information that must be maintained at that location.
The operating agreement will also contain restrictions on the transfer of members
interests and provisions for the admission of new members. Members will be required to follow
a specific process if they want to transfer their interests to others, and formal action by the
members is required to admit new members to the LLC. The procedures in the operating
agreement should be followed in order to prevent creditors of members or other third parties
from acquiring rights as members of the LLC.
The operating agreement also contains provisions relating to the death, incapacity,
withdrawal, expulsion, bankruptcy, or dissolution of a member. These provisions should be
consulted if any of these events occur. Prompt action may be required to prevent dissolution of
the LLC.

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Although LLCs are not required to hold annual member meetings, its a good idea for the
members to review the operations of the LLC at least annually. This may be a good time to
review the operating agreement to be certain the LLC remains in compliance with its terms.
4.

Further Advice

Neither this Memo nor the LLCs operating agreement can anticipate all issues that may
arise in the operation of your LLC, and neither document is likely to address all questions.
Accordingly, I encourage you to seek further legal advice if you have questions and particularly
before undertaking major changes or transactions affecting the LLC.
Please feel free to contact me if you need assistance with any of these matters or if
questions arise regarding the day-to-day operation of your LLC. I have appreciated this
opportunity to be of service to you and look forward to working with you in the future.

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