1. What is a California LLC?
A California LLC is a business entity that can limit the liability of its owners.
People that can emulate the tax and ownership characteristics of other entities, such as a sole proprietorship, partnership, or corporation.
Owners are called members and each member holds a membership interest based on his/her/its contribution amount to the LLC. It is created under state law by filing a formation document with the secretary of state. Under state law, an LLC has certain features that affect both member liability and creditor rights.
California LLC’s can be member-managed or manager-managed. In a California member-managed LLC, the members manage the company by membership voting. In a California manager-managed LLC, members appoint one or more managers to conduct LLC business as authorized by the members. A manager can be a member of the LLC but does not have to be. Even in a member-managed LLC, a “day-to-day” manager is sometimes appointed to conduct daily business operations, but without decision-making authority.
If you are looking to, or have just recently formed a Limited Liability Company, or LLC, there are some important facts that you should know.
Starting with the basics:
- a California LLC is a business entity that can emulate characteristics of other entities such as corporations, partnerships, etc.
- In an LLC, the owners (called Members) hold an interest based on their percentage of the contribution to the LLC or based on Membership Units.
- California LLCs can be either managed by their Members, or they can elect a Single Manager or Multiple Managers.
California Member Managed LLC
In a member-managed LLC, the members of the LLC manage the company via a voting system. In this system, the members normally only vote on big picture decisions, but rather assign a manager to run the day to day of the company.
California Manager-Managed LLC
In a manager-managed LLC, the members will elect one or more managers to run the business. The LLC’s Operating Agreement will grant the Manager(s) the power to make the day to day business decisions. The manager does not necessarily have to be one of the members of the LLC.
2. Observe California LLC Formalities Keep your Assets Shielded from Liability
First, it is important to understand the relationship of the LLC with its members. In the eyes of the state of California, an LLC is considered a “person” and is completely separate from its members. This, however, is only true if the LLC is properly managed.
Therefore, if the LLC is managed properly, then it should protect its members from personal liability.
In order for the State of California to recognize that an LLC is separate from its members, it is essential that LLC’s members and/or managers should keep business and personal affairs completely separate. Any income or disbursements that are made to or from the California LLC should be paid or received into the correct bank account.
For example, if the LLC receives rent from a tenant that is renting out a property owned by the LLC, then the rent proceeds should be deposited into the LLC’s bank account. Not the bank account of one of the owners.
LLC business transactions should only be done through the LLC’s bank account, not the personal Member accounts.
This is true for LLC expenses as well. Failing to follow this procedure can result in a court piercing the veil and going after the individual owner’s assets.
3. Do Members have Personal Liability in a California LLC?
In order for this to happen, the LLC must be managed in a way that all of the members respect the LLC as a separate entity. This means that all business done should be done under the name of the LLC, and not the individual members, and in doing so, the manager and members should only ever be referred to as such. It is also important to keep the personal accounts of the members separate from the business accounts of the LLC.
There should be no cross over or overlap between LLC business accounts and personal accounts.
For example, if the LLC is paid for a service carried out by the LLC, then the payment should be deposited into the LLC’s account and not the personal account of one (or more) of the members. Another example is managers fees. If manager fees are payable to the manager or member, then they should be paid via a written check from the LLC to the manager/member.
Practice LLC Tip: These practices help keep a paper trail and allow full transparency if any activity ever comes into question, to show everything has been done properly.
4. Should a California LLC have its own accountant?
Although LLCs are created to prevent the members from being liable, there are certain situations in which a member could be personally liable. The main way that this happens is if a member or members were not acting in according to the formalities talked about above.
Another way would be if a member (a person) acted adversely to a legal interest of the LLC (a person) and could be liable for damages in such a case. This only emphasizes the importance of communication between the members, the LLC and the LLC’s attorney, to ensure all parties are acting properly and within the law at all times.
It is also incredibly important to ensure that your team has a certified public accountant (CPA) who can give you guidance on issues related to income tax planning, compliance, and valuation.
5. How is an LLC taxed in California?
An LLC which has only one member is taxed differently from an LLC with two or more members. An LLC with one member is taxed as a disregarded entity. This means that the member will report profits and losses on Schedule C of the member’s 1040 Form. If the LLC has two or more members, then it is taxed as a partnership by default. In other words, the income each member derives from the LLC’s business, in that reporting year, gets reported on each member’s personal tax return.
The LLC will also be required to file an informational income tax return to report the money it made but does not pay income taxes. LLCs may elect to be an S-Corporation or a C-Corporation, which means the LLC is not taxed, but instead the income flows through the tax returns of the members. In this case, but business is known as a “pass-through entity.”
Before transferring property into or out of your LLC, please consult with your attorney or your CPA to be sure you are aware of the potential tax consequences of such transfers.
6. Do you Need to Still Carry Insurance if You Have an LLC in California?
Although your LLC will provide you with limited liability (assuming you have maintained it properly), it is a good practice, and in your, and the other members of your LLC’s, best interest to invest in a good commercial general liability insurance policy. It is also important to get specialized coverage based on your specific operations if necessary.
Good insurance coverage will likely protect you and cover the costs of your defense if you are sued, or forced to go to arbitration, and will significantly lessen any litigation costs as a result.
7. What other types of protection can you get from a California LLC?
Another way of protecting yourself is to create subordinate LLCs to own risky property. This can be used as a tool to contain damages that result from a lawsuit arising out of the property which created the liability.
LLCs are a way to insulate risky assets from safe assets, especially when the individual has personal risk. By creating a subordinate or separate LLC, this allows the safe assets held in the LLC itself (or a separate LLC) to remain uncontaminated if they are operated and managed properly.
You can also use an appropriate entity, such as a subordinate LCC, as Manager of your LLC, which provides another level of protection. Using an asset-protection entity ensures that none of the individuals are exposed to liability. This way you are able to protect the LLC and protect the manager together.
How to Operate A California LLC
8. Start by getting a Taxpayer ID or Employer Identification Number (EIN) for your LLC
If your LLC has employees or is not treated as a disregarded entity, then it must obtain a taxpayer ID number by submitting Form SS-4 Application to the IRS, to get an EIN. All of the LLCs, other business entities, and even some trusts whose own interest in the LLC must have a taxpayer ID number.
For an LLC, you can liken an EIN to a company’s social security number.
9. File a Tax Return for your California LLC
Because your LLC can be taxed in a variety of ways (disregarded entity, partnership, S-Corporation, C-Corporation), it is important to discuss the applicable required tax returns and filing deadlines with your attorney or your CPA.
DEPENDING ON YOUR TAX STATUS, YOU MAY BE REQUIRED TO FILE A RETURN EARLIER THAN APRIL 15.
Additionally, where the LLC is taxed as a partnership, the company must appoint a Partnership Representative to communicate with the IRS on tax and audit issues.
Remember there are four different ways that your LLC can be taxed.
4 different ways that a California LLC can be Taxed:
An LLC can be taxed as a disregarded entity;
An LLC can be taxed as a partnership;
An LL can elect to be taxed as an S-Corporation; or
An LLC can elect to be taxed as a C-Corporation (although very rare).
Regardless of how your LLC is taxed, it is imperative you discuss all required returns and filing deadlines with your CPA and attorney. It is important to do as soon as you get your tax forms, because depending on your tax status, you may be required to file your return before April 15.
NOTE: If your LLC is a partnership, then a Partnership Representative must be appointed to communicate with the IRS on tax and audit issues.
10. California Franchise Tax Board Fees for a California LLC
You will be required to pay the California Franchise Tax Board (FTB) fee of a minimum if $800.00 every year. If you fail to pay the FTB in a timely manner, your LLC may be suspended. If your LLC is suspended, it may affect your insurance, and your ability to defend lawsuits brought during that time. Ensure that you work with your CPA to ensure that you understand whose responsibility it is to pay this fee.
11. Obtain a local business license for your California LLC
YOU MUST get any local business license in the city and or country your business is headquartered in, even if you are working from home, or incorporated at your home address. The application may require you to get zoning clearance for your work site.
You also may need to register a fictitious business name, only if your business name used is different from the name registers in your Articles of Organization. You may need more permits depending on the nature of your business. If you have any questions about the permits your will need, please do not hesitate to contact us.
Every other year, you will also be required to submit an updated Statement of Information with the Secretary of State. Ensure that you do not forget to file
11. Is my California LLC required to pay Sales and Use Taxes
Your LLC may be subject to Sales and Use taxes and may require that you get a reseller’s permit from the state to operate your LLC.
12. California LLC Biannual Statement of Information Filing
In California, you must file an initial statement of information when you form your LLC. After the initial filing, you will need to file an updated statement of information once every two years. In addition, you should update your statement of information any time you change addresses or management.
LLC Tip: After you file your LLC, be sure to put this date on the calendar to ensure it is submitted in a timely manner. Failure to submit the Statement of Information on time will result in penalties.
13. Choosing a Registered Agent for Your California LLC
Your LLC is required to have a registered agent for service of process, and who is responsible for receiving the official mail and services of process. Whenever you make any changes to your registered agent, you must notify the secretary of state.
14. Drafting an Operating Agreement
Your operating agreement is the legal document that governs the relationship between the members and managers (if any), and provides how decisions are made within your company. Please review the operating agreement carefully to be sure you understand your obligations—and those of your fellow members, managers, and officers—fully. If you have any questions relating to any of the provisions in the operating agreement, do not hesitate to contact us. Abiding by the provisions of the operating agreement is imperative to keeping your liability shield intact.
Each LLC is required to have an operating agreement. Your operating agreement is a legal document and governs the relationship between the LLC’s members and the manager. It also describes how decisions are made. Make sure that you fully understand your operating agreement, and that all the LLC’s members and the manager fully understand the operating agreement.
You should have the operating agreement written by the LLC’s attorney, and approved by its members prior to its implementation. If you have any questions regarding what is required in an operating agreement or need help creating an operating agreement, please feel free to contact us. Your operating agreement will also provide several requirements, for example when the members of the LLC will be holding a meeting, and the frequency of those meetings, especially those meetings which are annual, special, required notices and waving notices.
15. Should your California LLC Hold Company Meetings?
It is always wise to hold regular meetings whenever your LLC is making a big decision. You should have someone take notes (also known as minutes) and follow any rules or procedures that are spelled out in your operating agreement.
16. Putting Other Limitations on Ownership of your California LLC (Buy-Sell Agreement)
Another legal document that will need to be created is the LLC’s buy-sell agreement, which controls what can be done with a member’s equity interest. Depending on the buy-sell agreement, a member may be restricted from selling, or even transferring their equity in the LLC. This includes but is not limited to transfers to family or revocable living trusts, and the buy-sell agreement may even control what happens to the equity interests if the member is no longer a part of the LLC (via death, divorce, disability, or leaves the LLC, etc.).
Violating the LLC’s buy-sell agreement or operating agreement could open you up to personal liability, so it is important that you know and understand your LLC’s internal documents
Based on the type of LLC you are, you may have further limitations placed on you by law. For example, if you are an S-Corporation, you may be limited from transferring membership interests due to a tax election, security regulation, and/or limitations within your operating agreement. Before taking any action to transfer or sell your ownership interest in your LLC, contact us, or speak with your attorney before doing so.
18. What is a Transfer Ledger and Should they be used in a California LLC?
After you are issued your membership interest in the LLC, the transfer ledger must be updated. Any time any interest in the LLC is transferred to a new member, the transfer ledger must be updated to reflect the transfer.
19. Contributing Real Property to your LLC to Create a California Real Estate LLC
Contributing real estate or contracts can be complex. Real estate transferred without lender consent can accelerate mortgage debt. This is commonly known as a “Due on Sale Clause”. Contributing leases or other contracts can void or change the terms between the parties. Contributing tax-deferred installment notes can accelerate the recognition of the deferred taxable gain.
If you are considering titling any real property in the name of your LLC, please contact your mortgage holder, or an attorney so you do not run afoul of any restrictions.
20. How to Title Assets in your California LLC
Here is an example of how your LLC should hold title to assets:
“YOUR NAME LLC” a California Limited Liability Company.
If you are titling real estate, it may be titled differently, therefore you should consult with an attorney in the state where the real property is located to ensure that your LLC is titled properly.
21. How Should Specific Assets Be Transferred to a California LLC?
The transfer of assets to an LLC is often called “funding.” When the assets being transferred to the LLC are being valued, that value is determined at the time they are contributed. Some assets may need to be appraised by a qualified appraiser, because their value is not readily discernible, for example, real estate, accounts/notes receivable, or business interests.
21.(a) Untitled Tangible Business Property
Untitled tangible business property is often things such as equipment, inventory, crops, and livestock. Generally, any property that is held without a title document. The best way to transfer untitled business property to an LLC is via a bill of sale or assignment. This SHOULD NOT include personal property such as household goods, furniture, or anything that is not used by the LLC.
21.(b) Titled Tangible Business Property
Titled tangible business property includes property such as vehicles (cars, boats, trailers, planes, etc.). These assets usually have a recognized title attached to them. Anytime a motor vehicle is transferred, check with your insurance company to verify continued coverage. Double-check with your CPA and attorney to check if any additional transfer taxes are going to be applied to the transaction.
22. Federal and State Securities Laws Relating to the California LLC
Any transfers or sales of LLC units or shares must comply will both federal and state securities laws. If you are unsure whether a transaction is in compliance with these laws, contact your CPA and your attorney immediately. Do not guess, and do not wait, the consequences for violating these laws are severe. Protect yourself by getting advice from your CPA and Attorney well before the transaction occurs.
The legal requirements relating to disclosure and registration of offering securities are complex. You should only transfer an interest after receiving sound legal and tax advice. If you do not properly handle matters from the outset, the financing opportunity may be legally barred.
23. Keeping Records of Your California LLC
State law states that certain records must be kept and maintained at the registered office of the LLC. Any member request to see these records at any reasonable time.
State law requires that the principal or the registered office of the LLC maintain and keep certain written records. Any member or assignee of the LLC can request LLC information at any time and make copies for free.
The following records must be in written form or can be converted to written form:
24. LLC Current Lists:
A current list includes the following:
- Current Name and address of each member;
- Percentage of LLC each member owns; and
- Names of the members of each class or group, if two or more LLC
- classes of interest are created.
25. Copies of LLC Tax Returns
The LLC must keep and maintain copies of all of its state, federal, and local tax returns. These should be kept for the last seven tax years.
26. Copies of Specific Documents
The LLC must maintain copies of documents such as the formation documents, Articles of Organization, the LLC’s Operating Agreement, all amendments, restatements, documents that create a class or classes or groups of members, and power of attorney.
27. LLC Written Statements
Copies of the following written statements must be kept and maintained.
- Cash contributions, agreed value of property contributed that members agreed to make in the future;
- Date and time further contributions are to be made;
- Any event which would require the LLC to be dissolved;
- Date each member became a member;
- Books and records of LLC accounts.
28. Maintenance of your California LLC
Always keep meticulous maintenance of your California LLC’s records. In your LLC’s office, keep an up-to-date copy of all books and records. In addition, all tax returns must be properly filed on time, and all state reports must be filed timely.
29. Total Cost of Setting up a California LLC
The total cost to set up a California LLC varies depending on whether you use an online service that provides a “one size fits all” approach or an experienced attorney who can help issue spot unique facts related to your business.
Our firm charges a flat rate of $1,500 to set up a California LLC. This flat rate includes the Secretary of State filing fees, Statement of the Information filing fee, Operating Agreement, and EIN Number.
Keep in mind, there is more than just the legal costs when setting up an LLC. We strongly advise working with an accountant or CPA to help you choose the best tax elections. Lastly, in California, there is a minimum annual franchise tax of $800.
If you have any questions or would like to set up a time for a phone consult with an LLC attorney please feel free to either schedule a call on our online scheduler or give us a call at (858) 869-1114.