DAVID J. WILLIS ATTORNEY
Copyright © 2013. All rights reserved worldwide.
LLC´S IN TEXAS – POST-FORMATION INSTRUCTIONS
with Comments Pertaining to Series LLC's and Asset Protection
by David J. Willis, J.D., LL.M.
The company recordbook should include your Certificate of Formation as approved by the Texas Secretary of State along with other important documents including the Company Agreement; the Minutes of the First Meeting of Members (also called the organizational minutes); and such other optional documents as you may have asked your attorney to prepare (e.g., warranty deeds, promissory notes, management/consulting agreements, leases, etc.). Your record book should also contain the company seal and printed membership certificates indicating the percentage ownership of each member. The membership certificates need to be signed and issued. The signed originals may be distributed to the members or, if they so elect, the originals may be retained in the book.
If you have not yet received faxed or written approval from the Secretary of State´s office, it should arrive shortly. It will reflect the date of filing and a filing number. When received, you should hole-punch the document and insert it behind the Formation Documents tab.
You should read the Minutes and the Company Agreement carefully and let your attorney know if you have questions or if changes need to be made. All locations with "sign here" flags should be signed. Once this is complete, your limited liability company is ready to do business.
Careful record keeping and bookkeeping are recommended. Note that Sec. 101.602(b) of the Business Organizations Code requires that the records maintained by a series LLC for a particular series must account for the assets associated with that series separately from the other assets of the company. So if you do business in separate series, keep series records separately, or at least utilize a labeling system that makes it clear which items of income and expenditure apply to which series or to the company at large.
Use the company recordbook regularly. Get a three-hole punch. Keep important company and legal documents (deeds, contracts, leases, and the like) under the appropriate tabs so they do not get misplaced. If you believe a document is relevant to your company, include the original or a copy in the company book.
If this office has formed your LLC, then attorney David Willis acted as the organizer of the company for purposes of filing the Certificate of Formation. This Certificate was signed by him with your approval as "General Counsel, an authorized officer," since the law requires that the Certificate be signed by an authorized officer. Following formation, Mr. Willis resigned that formal position but remains willing and available to assist with any legal matters that may arise. In the Minutes of the First Meeting of Members you accept this resignation and release Mr. Willis from further organizational duties.
The majority of LLC´s formed by this office are series LLC´s rather than a traditional LLC´s. The series format enables you, at your option, to created individual series (Series A, Series B, etc.) that are separate and insulated from other series. While not technically separate legal entities, each series has the power, in its own name, to contract, hold title to assets, and sue and be sued. Series are effectively sub-companies.
The series structure provides flexibility for future operations. More on this below. Note that if you are not yet ready to create series, then for now you can operate the company exactly the same as a traditional LLC.
The company is required to have a registered agent with a physical street address (not POB) in Texas. This office is available to serve as registered agent for an annual fee of $250. In this capacity we agree to receive and forward official company mail (e.g., from the State Comptroller, Secretary of State, legal demands, and the like) on your behalf and accept service of process in the event the company is sued. However, we ask that you not use our address for bills, bank statements, routine correspondence, and the like, as these are not part of RA services and will not be forwarded. Note that our registered agent fee is not a retainer for legal services. Also note that our services as registered agent are Texas state-level only. They do not include interfacing with the IRS or any other federal agencies. Should you wish at any time to change the registered agent, you may do so at www.sos.state.tx.us.
Your registered agent will forward official company correspondence to you but will dispose of junk mail and solicitations. You must keep your registered agent informed of any changes in your contact information, including email.
The basic company documents ("governing documents" is the formal title in Texas) are the Certificate of Formation, the Minutes of the First Meeting of Members (also referred to as the "organizational minutes"), and the Company Agreement. Neither the organizational minutes nor the Company Agreement are filed with the state.
The organizational minutes record the establishment and initial organization of the company, including the election of managing member(s) and/or officers and the ratification of the formation process and expenses. The date of the organizational meeting may be arbitrarily set to occur shortly after the effective date of filing of the Certificate of Formation. These minutes should be signed by all members and managers.
The Company Agreement governs the internal operation of the company, including rules relating to a quorum, voting procedures, distributions, transfer of membership interests, and other such items. It should also be signed by all members and managers.
Company Formalities – Avoiding Personal Liability
It is advisable to observe minimum company formalities if you want your company to be and remain an effective asset protection device. These formalities – including executing all of the organizational documents, issuing membership certificates, keeping records, having annual meetings, filing tax returns, and the like – are discussed in detail below.
Minimum formalities are not burdensome as a practical matter; and failing to adhere to them may make your company vulnerable to "piercing the corporate veil" – a legal doctrine that allows penetration of the liability barrier and holding members personally liable for company debts and acts. Should you have questions about these formalities – sometimes referred to as "company maintenance" – do not hesitate to ask. We also suggest that you read our web articles Piercing the Veil and Asset Protection in Texas.
It is not legally sufficient to have only the organizational meeting and nothing further. You will want to have a least one meeting – the annual meeting – every year. We suggest holding that meeting in January to start the new year right. At that meeting, the members approve and ratify the actions of the members (and officers, if any) and the company for the previous year, elect new managing members or officers for the coming year, set forth and approve any other noteworthy items (such as property sales and acquisitions), and adjourn. Members sign the minutes, including a waiver of notice.
It is important to have regular annual meetings – if only as a formality – that are reflected in writing in the company book. They can be brief – e.g., reciting those present, ratifying the prior year´s actions, electing new managing members, and then adjourning. Maintaining minimum company formalities helps ensure that the company´s liability barrier will remain solid. Should you need assistance in drafting the minutes of the annual meeting, any special meeting, or company resolution, please contact me.
You can of course have more meetings – called special meetings – at any time you believe it is appropriate for the company and its members to officially consider and approve any proposed company action. An example would be the acquisition or sale of property or establishment of a new series.
Also, a bank or title company may request a company resolution for a specific purpose. This is not an actual meeting, just a signed affirmation (usually a "one-pager") of company intent to take a certain action – e.g., opening a bank account.
Printed membership certificates are located at the back of the company recordbook. Issuing these certificates (i.e., filling them in and signing them) is a necessary formality. They can be torn out of the book along the perforated line and delivered to individual members, or they can remain with the book for safekeeping.
Usually these certificates arrive from the printer in pre-printed form indicating the member´s name and ownership percentage. If this is not the case, then you must complete these blanks. In the upper right-hand corner of each membership certificate, you will fill in the percentage interest you are issuing, e.g., if there are two members, 50% each, or if one member, 100% to yourself – however you have chosen to structure ownership. In the line which follows This certifies that . . . you insert the name of the person receiving the membership interest. In the next line, which begins is the owner of . . . you again insert the percentage interest. Then you sign the membership certificate where indicated in your capacity as managing member or president, as the case may be.
Keeping the transfer ledger is much like keeping a check book. It reflects how a membership interest was issued, to whom, under what certificate number, and when. It can also record when that certificate was surrendered.
The company seal should also be included with your company book. Although it has no true legal effect in Texas, it adds ceremonial and decorative value to official company documents. You should apply the seal inside the circle at the middle bottom of the membership certificates.
Assumed Name ("DBA") Certificates
Texas Business & Commerce Code (the "TBCC") Sec. 71.103 et seq. – the "Assumed Business and Professional Name Act"– requires a notarized DBA filing if your company or any series of the company proposes to do business under any other name than its registered name. Acquiring one or more DBA´s is an important part of our recommended asset protection program. While I am sure you spent considerable time thinking of a suitable name for the company, it should nonetheless operate under its assumed name whenever possible. This adds a useful layer of anonymity. The same is true for individual series of the company – these too can have DBA´s. Examples:
Company DBA: "ABC LLC doing business as Ace Investments"
Series DBA: "ABC LLC – Series A doing business as Calista Construction"
Business cards, checks, signage, etc. should reflect the names "Ace Investments" and "Calista Construction" – not the name of the company or series. There is no reason to give the public clues as to underlying ownership.
Assumed name certificates can be obtained from the Secretary of State (statewide) or from the local county clerk (for doing business within that particular county). The TBCC requires both although many smaller companies overlook filing a statewide DBA. What would a required filing look like? This is an example: "ABC LLC doing business as "ABC LLC – Series A." This would appear to satisfy the requirement of Sec. 70.103. However, that leaves open the possibility of optional filings for each series – which we recommend. Example: "ABC LLC – Series A DBA Calista Construction."
Obtaining the assumed name is a matter of filling out a short form and paying a small fee. When visiting the county clerk, go prepared with a copy of your company´s Certificate of Filing in case the clerk wants to see evidence of your company´s formation. You may acquire more than one assumed name. For more information on DBA´s, see our website article Assumed Names in Texas.
Again, it is the company, or an individual series of the company, not you personally, who is registering for the assumed name.
So what would be the full signature line for the company? The following is a suggestion:
ABC LLC - SERIES A DBA ACE INVESTMENTS
BY: [YOUR NAME], MANAGER
[OR IF CIRCUMSTANCES PERMIT A SHORTER VERSION]
The Recommended Two-Company Structure
BY: [YOUR NAME], MANAGER
If you have chosen to establish our recommended two-company structure in order to separate your assets from business activities, you have dramatically lowered the risk that your asset-holding entity will be sued. You should maintain this separation going forward, i.e., the management company should deal with the public, tenants, contractors, vendors and the like, and the holding company should remain quietly and anonymously in the background, avoiding contractual commitments. In legal terms, this means that it has "privity" with no one. A good example of privity is when two parties sign a contract or a lease. Privity is the basis for lawsuits. No privity, no lawsuit.
When acquiring property, use the management company to sign the earnest money contract and close. Afterwards, transfer the property from the management company into a specific series of the holding company.
Management and Consulting Agreements
If you have requested management and consulting agreements to facilitate capital flows between two entities, then these will be included in your company book under the contracts tab. The essence of this arrangement is that "management fees" flow from your holding company to your management company, and "consulting fees" flow in the reverse direction. This provides a convenient accounting label to facilitate routine monetary transfers between the two companies. If you have not yet requested management and consulting agreements, and now wish to have them, please let us know.
EIN (or TIN) and Bank Account
You will want to acquire an employer identification number (EIN) for the Company (or, if you like, for specific series as well) from the IRS if you have not already done so. The quickest way to secure an EIN is to go the IRS website (www.irs.gov) and apply online. Alternatively, you may complete the SS-4 form included with this company book and mail or fax it to: Internal Revenue Service, Attn: EIN Operation, Cincinnati, OH 45999, Fax number (859) 669-5760. Finally, an EIN may be obtained immediately by calling (800) 829-4933 between 7:00 a.m. and 10:00 p.m. Monday through Friday.
Why does this firm not usually obtain an EIN for its clients? The application form requests that the applicant list a "responsible party" along with that party´s social security number. I hope you understand that we are reluctant to assume responsibility for paying a client´s taxes.
In order to open a bank account, you will need to produce a file-stamped copy of the Certificate of Formation and provide the bank with the company´s EIN number (or at least indicate that it has been applied for).
Again, I emphasize the advisability of using an assumed name or DBA. You should open the account in the name of your company´s DBA and order checks in that name. The bank will want to see a copy of your assumed name certificate from the county clerk.
Each series of a Texas Series LLC is permitted (but not required) to have its own EIN, assumed name, and bank account. Note that Texas banks are new to series entities and you may have to explain to the bank officer what you are doing. If the bank is hesitant, direct them to Sec. 101.601(20)(b) of the Texas Business Organizations Code: "A series established in accordance with Subsection (a) may carry on any business, purpose, or activity, whether or not for profit, that is not prohibited by Sec. 2.003." You may also direct the bank to our website for more information.
I am often asked if individual series should have their own bank accounts. My answer to these accounting-type questions is always "check with your CPA," but from the legal standpoint my response is that individual series may, but are not required, to have their own separate accounts. The statute requires that series account separately for income and expenses – but that can be done internally, as a matter of bookkeeping – utilizing a labeling system which clearly labels items of income and expense that pertain to each series and to the company at large. So long as this kind of internal bookkeeping is maintained, it is fine to pay individual series expenses with a check drawn on the general company account.
Federal Tax Returns
Consult your CPA in all matters relating to state and federal taxation. This firm does not give tax advice. Having said that, the following is information that has been supplied to us by our CPA.
(1) Company IRS Returns. The company will have to file its own annual federal income tax return unless the company and its series are treated for federal income tax purposes as a "disregarded entity". A "disregarded entity" is disregarded as an entity that is separate from its owner for federal income tax purposes. Under the IRS default rules for entity classification (IRS Reg §301.7701-3(b)), a single-member LLC is automatically disregarded and a multi-member LLC is automatically taxed as a partnership (Form 1065). In the case where a natural person (Form 1040 filer) is the only LLC member, the disregarded entity is reported on the taxpayer´s Form 1040 – Schedule C. In a community property state (e.g., Texas), a husband and wife who wholly own an LLC as community property have the option of either receiving disregarded or partnership treatment (IRS Rev. Proc. 2002-69).
Alternatively, your CPA may assist you in filing the Entity Classification Election to receive tax treatment other than that provided by the default rules. For a single-member LLC, the other option is being classified as an association taxable as a "C" corporation (Form 1120); "S" corporation (Form 1120S) status also requires filing for an "S" corporation election. A multi-member LLC may also elect treatment for being classified as an association taxable as a "C" or an "S" corporation. Unless there is a compelling business reason to elect "C"" corporation status that is well researched, this status should not be elected.
In general, according to IRS regulations, once an entity has made its tax election, an election may not be changed for 60 months.
(2) Series IRS Returns. What about individual series? Must a series file its own tax return? It depends. If a series has its own EIN, activities different from other series, and/or a different membership structure, a separate annual federal income tax return may have to be filed for both the series LLC organization itself and for the individual series. Let your CPA know that he U.S. Treasury Department has proposed regulations (Sept. 14, 2010 at 26 CFR Part 301) which state that the IRS will treat individual series as separate entities – each of which may elect "pass through" tax treatment, if the established criteria are met. As stated in The Journal of Accountancy, this means that "[t]he tax treatment of the series will then be governed by the check-the-box regulations (Treas. Reg. §§ 301.7701-1 through 301.7701-3)."
The Journal of Accountancy states that "the IRS decided that the factors supporting separate entity status for series outweigh the factors in favor of disregarding series as entities . . . They specifically looked at the fact that the rights, duties, and powers of members associated with a series are direct and specifically identified. They also noted that individual series may have separate business purposes and investment objectives. The IRS concluded that these factors are sufficient to treat domestic series as entities formed under local law."(see http://www.journalofaccountancy.com/Web/20103328.htm). Among other things, this means that individual series will have their own K-1.
The IRS offers a helpful online "Tax Workshop" for new businesses designed to help small business owners learn their tax rights and responsibilities. Go to www.irs.gov/businesses/small/article.
Texas Franchise Taxes
As for Texas franchise tax, you will shortly after formation receive a letter from the Texas Comptroller of Public Accounts notifying you of the date on which your first state franchise tax report is due (May 15th) . It will also show your company´s state taxpayer number. You should take this to your CPA so that he or she can set you up for the filing of timely annual franchise tax returns. Note that this letter will also ask that you "please complete an online Franchise Tax Accountability Questionnaire with 30 days."
FILING TIMELY TAX RETURNS, WHETHER FEDERAL OR STATE, IS THE CLIENT'S SOLE RESPONSIBILITY, NOT THE DUTY OF THIS OFFICE. RECALL THAT WE ARE NOT TAX ADVISORS. FEDERAL RETURNS ARE DUE APRIL 15TH AND STATE RETURNS ARE DUE MAY 15TH. PUT REMINDERS ON YOUR CALENDAR. DO NOT EXPECT FURTHER WARNINGS OR REMINDERS FROM US, EVEN IF THIS FIRM IS SERVING AS YOUR REGISTERED AGENT.
Filings with the State of Texas
Two annual state filings are required:
(1) You must file a Texas franchise tax return with the Texas Comptroller even if the company has no income. It is due by May 15th of next year (not the year of formation). You are eligible to file the No Tax Due Information Report (Form 05-163) if your company is a passive entity as defined in Texas Tax Code Sec. 171.0003; if you have annualized income less than the statutory threshold ($600,000); if the company has zero Texas gross receipts; or if the company is a real estate investment trust (REIT) as defined by Texas Tax Code Sec. 171.0001(c)(4). If your company does not fall into one of these categories, you will likely be filing the EZ Computation Report (Form 05-169). If you have other Texas LLC's or entities, you will likely have to include an Affiliate Schedule (Form 05-166). Note that there is $50 fee for filing late. Discuss these matters with your CPA. These are all routine forms. He or she will know exactly what to do.
(2) The annual filing of a Texas Franchise Tax Public Information Report (the "PIR" found on Form 05-102) is also required by the Texas Comptroller. It is due by May 15th of next year (not the year of formation). It is a simple form.
Note that the PIR requires disclosure of the names of each current "officer, director, or member" of the LLC (This is different from the Certificate of Formation that we filed to organize the company – you may recall that we disclosure only the names of the initial managers – not members). Since LLC´s do not have directors, you do not have to worry about that; however, you will now need to fill in the name of any person or entity who is a member, a managing member, or a non-member manager. This of course has implications for any anonymity strategy you may have.
You should visit the Texas Comptroller´s website at www.franchisetax.tx.gov in order to acquaint yourself with information and resources available. The phone number is (800) 252-1381.
Failure to pay Texas franchise tax will result in the company´s right to transaction business, as well as the right to sue and defend itself in Texas courts, being forfeited. Note that if the company´s right to transact business is forfeited, the company´s officers, directors, partners, members or owners may become liable for debts of the entity, including taxes, penalties and interest, which are incurred after the due date of the report and/or payment (See Texas Tax Code Ann. Sections 171.251, 171.2515, 171.252, and 171.256). For future reference, to determine if the company is in good standing with the Texas Comptroller, go to www.ecpa.cpa.state.tx.us/coa/index.html or call (800) 252-1381.
Use a Good CPA
Even though this article has attempted to provide basic tax information, this firm does not give tax advice and cannot assist you with filing tax returns. Every businessperson needs both a good attorney and a good CPA. At your earliest convenience, you should consult a CPA concerning the best way to handle your new company for federal and state tax purposes. Certain tax benefits may be available but are not automatic.
A client recently asked "Why does your company agreement not include tax-related provisions for minimum gain chargeback, qualified income offset, and the like?" Our answer is that detailed tax matters are the province of your CPA. Mr. Willis works diligently to maintain expertise in real estate and asset protection matters, attending advanced seminars and doing independent research; he cannot possibly keep up with ever-changing tax law as well. If you believe these items need to be reduced to a writing signed by the members, then the appropriate action would be to obtain specific instructions on these issues from your CPA and then include them in a brief company resolution or special meeting – but this is not included in services provided by this firm.
Contracts, Leases, Deeds, and Other Agreements
In time, your company will likely enter into one or more of the following:
contracts with vendors
and more. These documents are no less important than your other company documents. Firstly, they should only be prepared with the assistance of an attorney who is an expert in the relevant area; and second, the originals should be kept in your company book under the appropriate tab. Good record keeping is part of maintaining your company´s liability shield.
leases with tenants
property management agreements
joint venture agreements
earnest money contracts to buy or sell property
letters of intent
deeds to property
bills of sale
How are series created?
Promptly after forming your new series company, you should transfer investment properties, assets, and businesses held in your personal name to a specific series (A, B, etc.) of the LLC. After all, that is the point of establishing a company with a liability barrier.
Note that if you transfer an asset into the company without specifying a series, it will become a general asset of the company at large. It will not be part of a specific series and will therefore not have series separation and insulation.
Pursuant to the Company Agreement used by this office, a series is created when a property, asset, or business is conveyed into it. No additional state filing or action by your attorney is required. Alternatively, one may elect to have a special meeting in order to declare the creation of a series. This method is useful if (1) the series will have a different membership or management structure than the company at large; or (2) you have other good reasons for wanting to have a signed document evidencing the creation of a new series. Generally speaking, documentation is a good idea. It is difficult to "over document" your company records.
Be aware, however, that it is not enough to recite in meeting minutes that a particular property is conveyed into a series. One must also follow up with a warranty deed transferring that property into that specific series and then record that deed in the county clerk´s real property records. The deed will be microfilmed by the clerk and then returned to you. You should then keep it in the "deeds" tab of your company book.
What sort of assets should be put into individual series?
Sec. 101.605(3) of the Texas Business Organizations Code states: "A series . . . has the power and capacity, in the series´ own name, to hold title to assets of the series, including real property, personal property, and intangible property." The individual series are, in effect, sub-companies and there is technically no limit to the number of series a company can have, although prudence might dictate that there is a reasonable limit to the number of properties one might to hold in a single LLC – even a Texas Series LLC. One should also consider carefully before "mixing and matching" entirely different businesses within the same company.
One should not place an enterprise in one series that:
(1) creates a much higher level of liability or potential for legal action than businesses in other series;
(2) has a significantly different debt structure (involving blanket development loans, personal guarantees, and the like) than that in other series;
(3) receives significantly different tax treatment from other series or is involved in a payment plan with the IRS;
(4) serves as a management entity with exposure to the public – tenants, vendors, contractors, and the like – this function is better placed in a separate LLC altogether.
Entities with the foregoing characteristics fall into the category of "single purpose entities" (known in the trade as "SPE´s"). Examples are restaurants, retail outlets, strip centers, apartment complexes, etc. These should be placed in a separate, stand-alone LLC. Caution: merely because the BOC permits entirely different enterprises to be contained within the same company does not mean that one actually should do so. Individual circumstances and goals must be closely examined and evaluated.
Transferring Property into the LLC
Investment property or going businesses which are currently held in a personal name should be moved into the LLC by means of a warranty deed or bill of sale, respectively, without delay. If yours is a series company, the deed or bill of sale should reflect the specific series the property is going into, e.g., "ABC LLC – Series A." If the particular series has a DBA (as it should), then title would go into "ABC LLC – Series A DBA Ace Investments."
If you are utilizing a two-company structure, then the management company should be the entity that signs an earnest money contract to acquire property and then closes on it. After closing, the management company should execute a deed into a specific series of the holding company.
It is our position that the warranty deed should also recite certain additional matters relating to the series structure of the company so as to put the grantee and others on notice of the insulation of each series from the other. Doing this makes it absolutely clear to others concerned that they are dealing with a specific series of the company and not the company at large.
Investors occasionally wonder if such transfers are permitted by the lender if there is a "due on sale" clause in their deed of trust. This is usually not a problem, since lenders seldom protest transferring real property into a personal company and, in any case, are far more concerned with loans that are in monetary default. In fact, this author has never seen a lender accelerate a loan merely because title to the property was transferred into the borrower´s personal company.
Note that it is not usually necessary or even advisable to transfer a homestead into an LLC, since the homestead is already protected by the Texas Property Code and Texas Constitution against forced sale or execution upon a judgment. Also, homestead assets seldom attract lawsuits, which is often not the case with investment properties. It is better to keep the two categories separate.
For more information on deed-related issues, see my article entitled Deeding Texas Property to an LLC.
Salaries and Wages
The Texas homestead laws protect current income. Pursuant to Sec. 42.001(b)(1), "current wages for personal services, except for the enforcement of court-ordered child support payments" is exempt "from garnishment, attachment, execution, and other seizure." As part of your asset protection planning, you may wish to establish a regular salary to be paid to you by the company. It is a good idea to have a brief employment agreement to support the assertion that such payments are indeed "current wages for personal service." Reason? Compensation paid to an independent contractor is not exempt. Note, however, that once wages are received by the debtor, they cease to be current wages and are not exempt from attachment, execution or seizure for the satisfaction of liabilities. In other words, cash in hand can be attached. For further details, see our article Homestead Protections in Texas.
Estate Planning/Probate Avoidance
Consider setting up a living trust for your homestead that will avoid probate and achieve a measure of anonymity. This should be accompanied by a "pour over" will to complete a basic estate plan that avoids probate.
All documents produced by this office in the formation of any company, including the Company Agreement, are proprietary and licensed to the client for use in connection with a particular company only. They may not be reproduced or re-used in any manner whatsoever without my express written permission.
The LLC documents produced by this office are continually evolving and improving as a result of changes in the law and the asset protection challenges that clients routinely present to us. We invite our clients to contact every year or so in order to update the company agreement or any other company document. A reasonable fee applies.
Information in this article is proved for general informational and educational purposes only and is not offered as legal advice upon which anyone may rely. The law changes. Legal counsel relating to your individual needs and circumstances is advisable before taking any action that has legal consequences. Consult your tax advisor as well. This firm does not represent you unless and until it is expressly retained in writing to do so.
Copyright © 2012 by David J. Willis. All rights reserved worldwide. David J. Willis is board certified in both residential and commercial real estate law by the Texas Board of Legal Specialization. More information at http://www.LoneStarLandLaw.com.