In our previous article on choosing a business entity, we looked briefly at some of the chief considerations that go into choosing a business entity and examined three business entities commonly used in Ohio, sole proprietorships, general partnerships, and limited partnerships (LP’s). In this article, we’ll look at limited liability companies (LLC’s), which offer more protection from business liabilities than sole proprietorships and general partnerships without being as complicated and expensive as a corporation.
In a limited liability company (LLC), every member enjoys limited liability. There are no general partners who shoulder the liability as there is with limited partnerships. Likewise, no member enjoys the full managerial control of a general partner unless chosen as manager of the company by the members. The membership as a whole may elect one or more members to fulfill managerial responsibilities for the business or hire a non-member manager. Responsibilities of each manager are defined by the operational agreement and can be changed by the board of directors.
An LLC requires organizational formalities and increased reporting and regulations similar to a limited partnership or corporation. Interests in a business may be transferred or sold, but not with the same freedom available to limited partners or shareholders in a corporation. Death or withdrawal of a member does not necessarily result in termination of the business.
Charging Orders and Creditor Claims Against an Ohio LLC
Up until May of 2012, some Ohio businesses who wanted to take advantage of the protections and flexibility of an LLC chose to form their LLC in one of a few select states other than Ohio, such as Delaware, Wyoming or Nevada. This is because, although the LLC entity was available in Ohio since 1994, the protective value of an Ohio LLC was previously uncertain. For many years, Ohio’s laws were vague in regard to whether the LLC structure protected the LLC’s assets against creditor claims for debts owned by the LLC’s members.
In states with the most protective LLC laws, the laws clearly state that, if a creditor had a claim against a member of the LLC, the only option the creditor had to collect on the member-debtor’s interest in the business is a charging order that requires any distribution of profits to the member-debtor to go directly to the creditor. While Ohio’s law previously stated that a charging order was a remedy for creditors, it did not state that the charging order was the only remedy.
In May 2012, an amendment to Ohio’s LLC laws went into effect and clarified that, in Ohio, a charging order is the “sole and exclusive remedy that a judgment creditor may seek to satisfy a judgment against the membership interest of a member or a member’s assignee”. Ohio LLC laws are now more protective than LLC laws in many other states and just as protective as those in Delaware, Wyoming and Nevada.
Single Member Limited Liability Companies in Ohio
Interestingly, an LLC is the only form of incorporation that allows the company to have only one member or owner. The advantage of a single-member LLC is that a business owner can have the liability protection of a corporation without sharing control of the business with anyone else.
However, there is a level of uncertainty as to how much protection a single-member LLC provides. Ohio’s laws don’t make any distinction between single-member and multi-member LLC’s. Therefore, one might presume that a single-member LLC protects against outside creditors (creditors with claims against a member rather than the business itself) just like a multi-member LLC would. However, that’s not how it has worked out in some other states. In some states without specific mention as to how a single-member LLC performs in regard to outside creditors, judges have ruled that, since there are no other members whose business interests need to be protected, a creditor can foreclose on the assets of a single-member LLC to pay the debt obligation of the sole member.
It’s also possible that should a case arise in another state where an Ohio single-member LLC does business or owns property that the laws of that state will be applied, rather than Ohio’s laws, and the single-member LLC will not be protected against an outside creditor. Additionally, a single-member LLC offers no protection to its assets if the sole member files for bankruptcy. Federal bankruptcy courts are able to ignore the protections that state laws provide to a single-member LLC.
Clearly, to ensure the full protective value of an LLC, there must be more than one member. In many cases, the second owner can be a spouse or other family member, who would likely benefit from the business’s profits anyway, and their interest might be as small as 1%. But they must be treated as a full member and co-owner, receiving distributions, receiving financial statements, participating in decision making, etc. If a co-owner is strictly a name on paper to give the appearance of a multi-member LLC, courts are likely to treat it as a single-member LLC.
Taxation Options for an Ohio LLC
Ohio law gives LLC owners a couple of options for the tax rules applied to their business. A multi-member LLC can choose to be taxed as a corporation or as a partnership. A single-member LLC can be taxed as either a corporation or as a sole proprietorship. If LLC members don’t elect to be taxed as a corporation, then the LLC is, by default, taxed as a partnership or sole proprietorship.
An LLC taxed as a corporation pays taxes on business profits and the members pay tax on their dividends from the LLC. This option is sometimes chosen when LLC members are exceptionally high income earners as the highest corporate tax rate is less than the highest individual tax rate and can, despite the double taxation, result in fewer taxes paid.
Members of an LLC taxed as a sole proprietorship or partnership pay no income taxes at the business level. Instead, members report profits and losses on their personal income tax returns. Usually, this results in fewer total taxes, simplifies reporting, and allows members to use business losses to offset other income.
At Gudorf Law Group, LLC, we regularly recommend limited liability companies as the entity of choice for small businesses. An LLC offers a favorable mix of owner control, limited liability and flexible options for estate planning, asset protection and raising capital. But an LLC is not right for everyone. In our next article, we’ll examine corporations, so you can see the advantages and disadvantages of these options and compare them to LLC’s and the other entities described in our previous article. Go there now.
Get help structuring your business to fit your goals and needs
In Ohio, the business planning attorney’s office of Gudorf Law Group, LLC, can assist in identifying and setting up the ideal business entity for your company, reduce your exposure to liability, and create opportunities to share business profits with family members or take advantage of outside investors without surrendering control of your business. Call our office at 1-877-483-6730 to schedule a free consultation.