Colorado LLCs
Filing, Amendment & Advisement
Limited liability companies (LLCs) are relatively new but popular entities that combine aspects of partnerships and corporations. LLCs are a popular choice because of the personal liability protection afforded to its owners ("members"). Moreover, LLCs also offer considerably greater tax and organizational flexibility than a corporation, partnership, or sole proprietorship would provide.
Limited Liability Companies
As of 2017, "LLCs outnumber[ed] corporations by more than two to one" in Delaware (the leading U.S. state when it comes to corporate law and formation). In Colorado, LLCs are formed at an even greater rate. This popularity is due in large part to the liability protection afforded to an LLC's members.
Personal Asset Protection
Much like a corporation, an LLC is a legal entity separate from its ownership and is therefore capable of creating and having its own obligations. For this reason, an LLC's members are not automatically liable for business debts or obligations the way a sole proprietor or the partners in a general partnership would be.
So long as properly created and certain formalities are consistently followed, an LLC's members have personal liability protection and will be shielded from business debts and obligations.
So long as properly created and certain formalities are consistently followed, an LLC's members have personal liability protection and will be shielded from business debts and obligations. As a result, the LLC's creditors and others to whom the business is liable will not be able to collect from the personal assets of the LLC's members.
This personal asset protection is an important reason to form an LLC instead of operating your business as a partnership or sole proprietorship. While generally significant for any business, just how important this liability protection is will depend on the owner's assets and the risks involved in the business.
Will you have employees that drive for your business or handle dangerous materials or equipment? Will you have customers coming onto company property? Will you be serving food or alcohol?
These are just a few common questions, but there are many more that could be relevant to your business depending on the risks it or its employees generate. But the conclusion that many reach having considered potential business liabilities is that a limited liability entity is right for their business, and an LLC is the only entity that will work for nearly any combination of owners and nearly any desired management structure.
As a result, many form an LLC in order to attain the personal liability protection it provides. But it is not enough to simply form an LLC to obtain personal asset protection, the LLC must also follow certain "formalities" laid out in its operating agreement or provided by default rules.
An operating agreement is an LLC's governing document that expresses the understandings and agreements among its owners.
When members operate without an explicit agreement or where the agreement is silent, the statutory default rules will operate to fill gaps in the arrangement, specifying the extent of the members' rights and obligations as well as the conditions for important business events (like its sale or dissolution).
For more on the dissolution of an LLC, see the article titled: Drafting LLC Operating Agreements to Avoid Judicial Dissolution
Where an LLC does not properly follow the procedures and conditions specified by default rules or its operating agreement, a court may decide to "pierce the veil" of the entity. That is, the court may disregard the LLC's separate existence and hold its members liable for the debts or obligations of the business. Two articles on this site discuss "veil piercing" more fully: The Current State of Veil-Piercing Law (Colorado) and LLC Talk: Single-Member LLCs - Asset Protection.
Any LLC member who wants asset protection from the entity should have a well-drafted operating agreement, unless they are familiar with all of the Colorado LLC default rules and are happy with their application to the LLC.
As a result, any LLC member who wants asset protection from the entity should have a well-drafted operating agreement, unless they are familiar with all of the Colorado LLC default rules and are happy with their application to the LLC. This is true whether the LLC is single member or multi member. It is the LLC's operating agreement that specifies the procedures that must be observed in practice in order to maintain the liability protection of the entity.
LLCs are generally referred to as "creatures of contract." This means that they are governed by the understandings and agreements of its owners who are free to reach an agreement from a wide range of management and organizational possibilities. This is unlike a corporation which is legally required to have a fairly limited ownership and management structure.
An LLC's organizational flexibility allows members to shape their business as well as the rights and obligations of members and managers according to the terms of their operating agreement. In Colorado, as elsewhere, courts are supposed to give "maximum effect" to the terms of these agreements.
In this way, an operating agreement not only helps maintain the personal liability protection of the members, but it also allows them to work out answers to important company questions in advance to help avoid costly disagreements down the road. For example, creating an operating agreement allows members to draft conditions for important events, such as changes in ownership or dissolution. Without an operating agreement in place, these events will be determined by the statutory default rules.
Under these default rules, LLC membership interests are freely transferable. If you're looking to transfer your interest, this may be a welcome result. But it is quite likely that the other members will not appreciate having a new and unexpected owner enter the business. For this reason, drafting restrictions on the transferability of membership interests is quite common.
An LLC's operating agreement permits members to draft any limitations or restrictions according to their agreements the members. It also helps to make sure everyone is on the same page in the beginning, before someone is looking to transfer some or all of their interest in the company. For more information, please see the section on LLC operating agreements.
LLC Tax Treatment
LLCs are also a popular choice due to their flexible tax treatment. Whether single member or multi member, LLCs can choose from a few different treatments, but the tax options available to a particular LLC depend upon the number of members.
For a single-member LLC, the default is to be disregarded much like a sole proprietorship would be. A disregarded entity is ignored for tax purposes and neither pays taxes as an entity nor has to file any report with the IRS. Instead, individual members are taxed personally based on their share of company income.
For a multi-member LLC, the default is to be taxed as a partnership. Like disregarded entities, partnerships are "pass-through entities" that are not taxed as entities, but they do have to file an annual report with the IRS and issue K-1s to members.
As with single-member LLCs, the members of LLCs taxed as partnerships pay personal income taxes based on their share of company income, as specified on their K-1.
Regardless of whether an LLC is single or multi member, the LLC may elect to be taxed as a corporation. And even here there are a couple options. First, an LLC may be taxed as a C-corporation. C-corps are taxed at the entity level and its owners are also taxed based on the income they receive from the business.
Regardless of whether an LLC is single or multi member, the LLC may elect to be taxed as a corporation. And even here there are a couple options.
This is sometimes referred to as "double-taxation" since the entity first pays taxes at the corporate level based on its income, and then the individual owners also pay personal income tax based on the income they personally receive from the business. But because an LLC taxed as C-Corps is taxed at the entity level, the owners or shareholders cannot deduct any losses of the business on their personal taxes.
However, an LLC taxed as a C-corp is entitled to special deductions not available to other entities, including the ability to deduct employee health insurance costs. (And, as with corporations ore generally, an LLC's members may also qualify as employees of the company.) LLCs can elect to be taxed as a C-corp by filing IRS form 8832. For more information about making this election, visit About Form 8832, Entity Classification Election.
The second option for an LLC taxed as a corporation is to be taxed as an S-corporation (so long as certain eligibility conditions are satisfied). LLCs taxed as S-corps are a common arrangement for many businesses and, depending on the net income of the business, there can be important tax savings by making this election. More about these potential savings and the eligibility requirements is discussed in the S-corp section of the corporations page.
To elect to be taxed as an S-Corp, you need to file IRS form 2553. For more information about making this election, visit About Form 2553, Election by a Small Business Corporation. An LLC no longer needs to file IRS Form 8832 before filing Form 2553 to be taxed as an S-corp.
However, there can be considerable tax consequences in electing to be taxed as a C-Corp or an S-Corp -- or for ending any such treatment. As a result, it is a good idea to speak with an experienced tax advisor or attorney before changing an LLC's tax treatment.
LLC Formation & Articles of Organization
An LLC is formed when its Articles of Organization are filed with the Secretary of State. The Articles themselves are generally relatively short documents, but they carry considerable significance.
In order to complete this filing, a handful of names and addresses are required, including those of the initial members, the registered agent, the person(s) forming the LLC, the individual filing the Articles as well as the address of the LLC's principal office.
It is important to consider carefully the answers to these questions -- much of this information will be public. However, an experienced business attorney can help you keep much of your personal information off this public record.
In addition to providing the information above, you'll be asked to determine the management type of the LLC. This management election is the most important question in the Articles.
LLCs may be created as either member-managed or manager-managed. In a member-managed LLC, the members participate directly in the management of the business much like general partners do. In a manager-managed LLC, ownership is separated from management in much the same way as a corporation.
The seemingly simple management election in the Articles of Organization carries considerable significance for the structure of the business and the rights and obligations of the members.
However, the same person may be both a member and a manager, with the rights and responsibilities of each role.
The seemingly simple management election in the Articles of Organization carries considerable significance for the structure of the business and the rights and obligations of the members. Do you want each person with a membership interest to be able to act on its behalf and bind it to obligations? How should powers and duties be defined? Are limitations or expansions warranted?
For a more detailed discussion of this management election, please see the article titled LLC Talk: Management Structure - Member or Manager Managed?.
Who has the authority to bind your business is important not because of that actual authority, but also because of the apparent authority it creates. In a corporation, for example, a shareholder cannot take out a loan for the business; they lack the authority to do so. An officer, however, may be able to do so.
Apparent authority arises when someone who actually lacks the authority to obligate your business, reasonably seems to a third party to have that authority. In that case, they may be able to bind your business without any actual authority to do so. For a more complete discussion of apparent authority and its dangers, see Understanding Apparent Authority: How an Unauthorized Partner Can Bind Your Business.
As a result, the management election in the Articles determines not only who manages the day-to-day operations of the business, but also who has both the actual and apparent authority to obligate the company in various transactions with third parties. For this reason, it is important to consider this election carefully in order to avoid unfortunate results.
The Pote Law Firm works with small business owners to help them properly file or amend their Articles of Organization and to draft or revise operating agreements. If you need assistance with forming an LLC or drafting or reviewing an operating agreement, Reach out, Today!
Public Benefit LLCs & B Corp Certification
While many social entrepreneurs are aware that they can form public benefit corporations (PBCs) in Colorado and elsewhere, fewer are aware that nearly any entity can be operated as a public benefit business. And LLCs are no exception.
Although there is no "off-the-shelf" option in Colorado to form a public benefit LLC (PBLLC) - there are only five states that currently have such statutes - LLCs are already flexible enough so that it can be organized and operated as a public benefit business.
To effectively create a PBLLC in Colorado, you must lock in a public oriented mission and expand the duties of management so as to require the company to consider all of its stakeholders and to operate in a sustainable and responsible manner. Both of these can be achieved by modifying an LLC's operating agreement
These changes are also required of any LLC that wishes to become a certified B Corp B Corp certification is available to any for-profit business that has committed itself to attaining significant social and environmental benefits and verifying the achievement of those results.
This verified certification is performed by B Lab, a nonprofit organized for the purpose of promoting business as a force for good, and businesses must take and pass the B Impact Assessment in order to become a certified B Corp.
For more information about PBLLCs, B Corp certification, and why your business may wish to pursue one or both, please see Public Benefit LLCs in Colorado: Is a Purpose-Driven Business Right for You? And if you need assistance forming a PBLLC or converting an existing LLC, please Reach out, Today!