Corporations, LLC's or Sole Proprietorship
Avoiding Bear Traps
By: John G. Pierce
Board Member,
Central Florida Real
Estate Council
Owner: Pierce & Associates
Real Estate Professionals and their clients are constantly faced with the dilemma of how best to structure their business operations which may be an operating entity or a real estate investment holding enterprise. Notwithstanding the common assumption in recent years that LLC's are the "best thing for every purpose", a detailed examination of the opinions of knowledgeable business and tax lawyers and CPA's is contrary to that dangerous automatic assumption. The rules of partnership taxation and the other requirements and legal technicalities involved with LLC's, could lead to some traps.
The LLC form of business grew out of the civil law countries of Europe and Latin America beginning in Germany in 1892 and spreading throughout Europe, Central and South America in the first half of the 19th Century. The first LLC enabling statutes in the United States was passed in Wyoming in 1977 and utilized the vehicle similar to the Latin America "Limitada". Initially, other states were slow to follow because of the uncertainty regarding the Federal tax status of the LLC (whether it would be taxed as a partnership or a corporation).
The Florida legislature adopted its first enabling statute in 1982 making Florida the second state to adopt the LLC as a recognized form of business. The use of this new vehicle was slow to develop because of the uncertainty over how the IRS would classify LLC's for tax purposes. After much deliberation, the Internal Revenue Service finally issued a public ruling in 1988, that a Wyoming LLC could be taxed as a partnership even if none of the owners were personally liable. In 1989, a private letter ruling was issued by the Internal Revenue Service applying the same analysis to a Florida LLC. In 1998, the legislature amended chapter 608 of the Florida statutes adopting the Federal tax classification of LLC's and exempting LLC's from Florida's corporate income tax. Since that time, the entity has become one of the most preferred business entities in Florida.
Notwithstanding the many benefits offered by the LLC, there are potential traps for the unwary and thus the selection and implementation of this or any other form of business requires careful planing with the proper professional assistance.
As a result of clever marketing by those who seek to sell corporate or LLC "packages" to the uninitiated person with the representation that they can be adopted and implemented without the necessity of any professional advice and guidance, people sometimes later find themselves faced with problems they never anticipated.
Both corporations and LLC's have the great benefit of providing limited liability to the members of the entity. This concept of limited liability which was birthed in England many centuries ago is of great benefit to the investor. Most anyone starting up a business today recognizes the need to try to protect themselves personally from litigation arising out of their business operation. Insurance can only do so much and most professionals would advise anyone starting a business, to operate it under a form which provides limited liability to the members.
One of the common problems which corporate and business attorneys see is that persons who form their own business entity and who started without proper legal advice are not well educated as to the steps required to complete the business formation and the subsequent statutory requirements to operate under the business entity. It is not at all uncommon for corporate attorneys to have a new client bring in to them what I call a "nude minute book", which for purposes of my definition would include one in which the founder created or received the Articles of Incorporation and perhaps a set of by-laws from a printed format by a bulk seller of those materials but with little or nothing else in the book. Operating under an entity such as this is what led the courts many years ago to "pierce the corporate veil" and to rule that the entity did not provide limited liability to its members because the founders did not follow the statutory requirements to properly complete the formation of the entity including adopting organization minutes, electing officers and directors, properly issuing the shares to the shareholders and continuing to hold and document meetings at least on an annual basis as required by the statute.
The same thing is occurring currently with some persons who form their own LLC by adopting and filing with the Secretary of State, Articles of Organization which creates the entity, but doing nothing further with respect to completion of the formation of the LLC. The Articles of Organization as required by the Florida statues are deceptively simple and the company comes into existence on the date and time that document is filed with the Secretary of State, unless otherwise provided in the instrument.
The Articles of Organization are required to be executed by at least one member, but are not required to state how many other persons are members, or to identify them. Florida statute 608.4101, requires each LLC to keep at its office (a) a current list of the full names and addresses of all of the members), (b) a copy of the Articles of Organization and any other documents filed with the Department of State, (c) copies of all of the LLC's tax returns for the 3 most recent years, (d) copies of the Operating Agreement and any financial statements of the LLC for the 3 most recent years and (e) a writing stating (1) the amount of cash or other property contributed by each member ( 2) the times at which any additional contribution is to be made by each member, and (3) any events which would constitute a dissolution of the business.
The statue permits the "operating agreement" to be either written or oral and requires that it contain provisions adopted for the management and regulation of the affairs of the LLC and that sets forth the relationships of its members and managers. An amazing number of persons form LLC's and rely on some degree of oral understanding as to the terms of the Operating Agreement without ever reducing that to writing. This is extremely dangerous because, like most oral agreements, they are susceptible to all types of ambiguities, disagreements and misunderstandings that can result in problems and can lead to litigation between the parties in which the issues of this "unwritten agreement" are submitted to a Judge or a Jury who then must try to decipher what the parties intended when they formed this business and what their agreement really was. No one in his right mind wants to be a party to such a dispute. The only person with the advantage in that circumstance, is the one member who signed the Articles of Organization and who is often the only stated member.
Various forms of Operating Agreements have been authored by many legal scholars, but it is sufficient to say that the check list of provisions suggested to be considered in the Florida Bar Publication for limited liability companies in Florida, is 18 pages long. Anyone who attempts to prepare such a document without proper legal assistance is literally playing with fire.
A single member LLC is authorized under the Florida statues and because there is no one else to argue with except the founder, it becomes a really simplified form of creating limited liability for the founders business or investment. Where there are multiple members of the LLC, a whole new series of questions arise, including, what each member is supposed to contribute, how are they supposed to be compensated, what happens with profits of the business, what happens when there is a sale of part or all of the assets and any tax questions that are far more complex compared to how they might be treated under the classic S corporation which is less complicated. The reason for this difference is that a multi-member LLC is treated as a partnership unless the entity elects to be taxed as a corporation and the partnership tax rules that apply in the absence of such an election can be far more complex then the average person would ever realize. An example of this is that owners of an LLC which is being taxed as a partnership must pay self employment tax on all of their income unless the partner is treated as a "limited partner". This is far different then what an investor would have expected if he was accustomed to operating under an S corporation where he received a portion of his profits through payroll with the balance being distributed to him as dividends which are not subject to self employment tax. Another sample problem that can arise is, in the event a member contributed property burdened by debt. The LLC members share the LLC's debts and if the property is sold by a buyer who assumes the debt, income occurs to all of the members by reason of their having been relieved of the debt. There is often in that circumstance no cash with which to pay the tax. SURPRISE!!
The use of an LLC in the operation of a business entity, as opposed to operating under a sole proprietorship, or an S corporation can have substantial benefits under certain circumstances, but it is no means safe to assume that it is the best vehicle for all purposes. The formation and operation of any business entity, requires careful planning and proper professional advice in order to avoid surprises that no one wants to experience.
The office of Pierce & Associates is located at 800 N Ferncreek Avenue, Orlando Florida. Information about the firm may be obtained at its website, The Central Florida Real Estate Council is a group of experienced Real Estate Attorneys who are committed to delivering timely expertise in negotiating in closing real estate transactions and providing title insurance services. Many of its members are well versed in corporate and business law. For more information, please visit Through its attorney members, CFREC offers this column on real estate, and other commonly related legal issues, as a service to ORRA members. Articles such as this are offered to provide a general understanding as to the law on various topics of interest and are not intended as a substitute for individual legal consultation, and should not be relied on in specific situations without consulting with a qualified attorney.
