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Delaware LLC | How to Start | Advantages | Operating Agreements

A Delaware “Limited Liability Company,” or “Delaware LLC,” is a Type of Entity (company) which is often described as a hybrid between a Corporation and a Partnership.

  • The Delaware LLC features the liability protection of a Corporation, in that the liability of all members is limited to their investments in the LLC (unless they personally guarantee other debt incurred by the LLC), but is more flexible in respect to management structure and is usually considered to offer greater ease of administration.
  • We charge $50 plus Delaware state filing fees which vary depending upon the type of entity you choose.

How are Delaware LLC’s Managed?

  • The management of a Delaware LLC is almost unlimitedly flexible.
  • Delaware LLC’s can be managed by the Members (owners) or by Managers (employees or agents who do not hold an ownership stake in the company).
  • Members can be divided into classes or can all hold the same voting rights or entitlements.
  • Any degree of restrictions or rights can be assigned to a Member, Manager or Class of Members.
  • Here are some examples: All Members can be given equal voting rights and issues are required to be determined by majority vote; or one person can be given absolute control while the other Members have no voting rights and are “silent partners”; or a Single Member LLC automatically passes all decisions by “unanimous consent”.
  • Other arrangements are also possible and can be defined in the Operating Agreement.
  • If the members of the Delaware LLC desire, they can even form a Board of Directors and appoint Officers, although this is neither traditional nor necessary.

How are LLC’s Taxed by the IRS?

  • The Delaware LLC is the most flexible entity (company type) currently in existence.
  • Delaware LLC’s can be taxed several ways.
  • A one-Member Delaware LLC is, by default (unless the LLC elects otherwise), taxed by the IRS as a “Disregarded Entity”; which means the profits and losses of the Delaware LLC are reported on the Member’s personal income tax return and no Corporate Income Tax return is filed.
  • An Delaware LLC with two or more members is taxed, by default, as a Partnership, which is also taxed as a Disregarded Entity: taxable income and losses “Pass Through” to its members.
  • Although the income and losses are reported on each partner’s personal income tax return, a partnership must also file an informational report, form 1065 and Schedule K-1.
  • A Delaware LLC may also be eligible to elect to be taxed as an S-Corporation.
  • The advantages of being taxed in this manner are the avoidance of double taxation that would occur if the company were a C-Corporation plus the possibility of being taxed at a lower rate.
  • A Delaware LLC may even be eligible to elect to be taxed as a C-Corporation, if it desires.
  • A C-Corporation may be taxed at a higher rate, but some Member’s prefer to fully deduct Health Insurance and Life Insurance Benefits as the Owner-Employee of a C-Corporation may do.

How are Delaware LLC’s Taxed by the State of Delaware?

  • Delaware LLC’s pay a flat tax of $300 annually to the Secretary of State of Delaware to maintain their Delaware Charter.
  • This tax has no relation to assets, income or activity level.
  • The Delaware LLC tax is due before June 1st each year and is never pro-rated for any reason.
  • If the Delaware LLC Tax is not received by the Secretary of State by the last day of March, a $200 penalty is assessed with 1.5% interest per month.
  • If the Delaware LLC tax is not paid for consecutive years, the Delaware Charter is declared VOID; the company becomes invalid and has no right to transact business or investments as an LLC.

Advantages of Delaware LLC’s

  • As of December 1997, all states, plus the District of Columbia, have passed laws governing the administration and operation of LLCs within their jurisdictions.
  • But Delaware LLC’s do posses some unique advantages and benefits:
    • One person LLC’s are permitted by Delaware statute.
    • Delaware LLC’s may have perpetual life, this means the company’s Charter does not “expire”.
    • Delaware LLC’s may be registered “anonymously” and are not required to file an Annual Report.
  • What are the advantages of operating as an LLC for non-resident non-citizens?
    • A Non-Resident Alien (NRA) usually is only subject to U.S. Income Tax on U.S. Source Income.
    • Generally foreign source income received by a nonresident alien is not subject to U.S. taxation.
    • Therefore, a non-resident non-citizen with no Operations (no business activity, no employees) within the US, and no property in the US, pays no US Federal Income Tax.
    • Furthermore, if your only U.S. business activity is trading in stocks, securities, or commodities (including hedging transactions) through a U.S. resident broker or other agent, you are not considered engaged in a trade or business in the United States. [Source: http://www.irs.gov website, November 18, 2009]
    • A Delaware LLC is not required to disclose the names of the Members at registration and does not file an Annual Report in Delaware.
    • The identity of the Members is private.
    • The Delaware Limited Liability Company Act does not require that a limited liability company agreement be in English.

The Delaware LLC as an alternative to a Partnership

  • A Delaware LLC is very similar to a Partnership: a multi-member LLC is taxed as a Partnership by default (although it may elect otherwise), and it is governed by an Operating Agreement which is similar in many ways to a Partnership Agreement; but there are distinct reasons to consider an Delaware LLC as an alternative to a Partnership:
  • Each member enjoys Limited Liability, as compared to the risk of unlimited liability that general partners must face in a partnership.
  • Unlike limited partners, Delaware LLC owners may participate in company management without fear of losing their protected, limited liability status.
  • Delaware LLC members may be able to avoid the I.R.S. passive-loss limitations and take federal income tax deductions for losses caused by the business – a benefit often unavailable to limited partners.
  • An Delaware LLC owner may obtain additional tax advantages from a special “step-up” option, previously available only to partnerships, under Section 754 of the Internal Revenue Code.

The Delaware LLC as an alternative to an “S-Corporation”

  • In Delaware, “S-Corporation” is a tax status, not an Entity Type. In fact, an LLC can be taxed as an “S-Corporation”.
  • For the purposes of this discussion, we will focus on the differences between an LLC taxed as a Disregarded Entity and a Stock Corporation which elects S-Corporation status.
  • Because a Delaware LLC is by default a “Pass Through” entity for tax purposes, the Members of an LLC automatically enjoy the liability protection of a Corporation, with the avoidance of double taxation that a Sole Proprietor or Partnership enjoys, without having to elect S-Corporation status as a Corporation seeking Pass Through status would have to do.
  • Furthermore, the Delaware LLC can enjoy Pass-Through status without having to continuously pass the “tests” that a Corporation electing S-Corporation status must pass to qualify.
  • Membership is not limited to Natural Persons as is the case with S-Corporations. Corporations, Limited or General Partnerships, estates, charitable organizations and pension plans are all permitted to be Members of a Delaware LLC.
  • Unlike an S-Corporation, a Delaware LLC does not limit the number of Members to 100. Unlike an S-Corporation, a Delaware LLC does not bar foreign persons from Membership.
  • The law allows the inclusion of liabilities of the Delaware LLC in order to increase basis for tax purposes (as in the case of a partnership).
  • Payment to a retiring Member may be structured so as to allow part of the payment to be deducted as an expense to the LLC.
  • A Delaware LLC may own 100 percent of the shares of Stock of another Corporation, whereas the S-Corporation is limited to owning 80 percent (with the exception that one S-Corporation may own 100 percent of a subsidiary S-Corporation).
  • An S-Corporation is limited to one share class, while an LLC may form separate and multiple classes of Members with dissimilar voting or distribution rights.
  • Delaware LLC owners may obtain additional tax losses from their allowable individual percentages of certain company liabilities, rather than solely through direct loans, as required in the case of S-Corporations.

Is there a downside to a Delaware LLC?

  • The benefits for owner-employees, such as health care or life insurance, are only partially deductible from these Members’ individual federal income tax returns, if the Delaware LLC is taxed as a Pass-Through entity or S-Corporation.
  • This is typically not a primary concern for entrepreneurs who are considering a Delaware LLC.
  • Unlike shares of Stock, Membership units of a Delaware LLC cannot be publicly traded.
  • If you are trying to raise Capital, some potential investors may be less familiar with Delaware LLC’s and the Delaware LLC’s Membership Interest Share versus the Corporation’s Stock Share.

Certificate of Formation

  • Delaware LLCs will be created by filing the Certificate of Formation.
  • This document is sometimes called the Articles of Organization or Articles of Formation.
  • DBI will draft this document for you. Any information needed from you will be obtained from your online order.
  • The following information will be included on the Certificate of Formation:
  1. The name of the LLC
  2. The name and address of the Registered Agent
  3. If the name of the Member is to be printed on the Certificate it will appear as the Third article. If the Certificate is Anonymous, the powers of the Member will be Article Three and so on
  4. The powers of the Initial Member are outlined
  5. The duration of the LLC is given to be perpetual
  6. The signature of the Organizer
  • DBI will act as the Organizer of your Delaware LLC.
  • The Organizer has the power to represent the company as an agent during the process of creation.
  • The Organizer has the authority to prepare, sign and file the Certificate of Formation and any other needed documents.
  • The Organizer’s authority ends when the Delaware LLC is registered and the Initial Member or Manager is appointed.
  • An Organizer is not an owner or officer.
  • Our goal is to include the minimum amount of information necessary on the Certificate of Formation.
  • Any additional provisions can be indicated in the Operating Agreement; by including additional provisions in the Operating Agreement rather than the Certificate of Formation, we can avoid the necessity of filing an Amendment to the Certificate of formation if any of the additional provisions change.
  • We can also avoid costly per-page charges which add up when you file a multiple page Certificate of Formation.
  • Filing the minimum provisions allows maximum flexibility and economy.
  • If you want additional provisions included on your Certificate, we would be happy to accommodate you if you supply the exact language of the additional articles.

What is the Operating Agreement?

  • Most “Articles of Organization”, also known as a “Certificate of Formation”, are deliberately spare in detail, defining only the minimum traits required to establish the Delaware LLC.
  • The reason for this is to allow the Delaware LLC to define its own provisions in its Operating Agreement; which saves the Delaware LLC from having to file an Amendment with the State if a change is needed, and keeps the organizational details of the company private.
  • An Operating Agreement is similar to the “By-Laws” of a Corporation in that it defines the specifics of the regulation of the of the company’s business and is similar to a Limited Partnership Agreement in that it defines the terms that the Members will adhere to regarding admission of new members, assignment of interest, appointment of voting rights and dissolution of the association.
  • Your purchase of a new Delaware LLC Registration Package includes an Operating Agreement Kit which comes with your choice of a model template (Microsoft Word .doc), or a fill-in-the-blanks form.
  • The following standard Articles are included in the model Operating Agreement:
    1. Definitions
    2. Organization of the Company
    3. Members (Status, Rights and Duties of)
    4. Management of the Company
    5. Managers (Status, Rights and Duties of)
    6. Officers
    7. Capital
    8. Distributions to Members
    9. Profits and Losses
    10. Admission and Withdrawal of a Member; Transfer of Member’s Interest
    11. Conversion and Merger with Other Entities
    12. Dissolution, Winding Up & Termination
    13. Books and Reports
    14. Miscellaneous
  • If you wish to include additional provisions please indicate that you want the Word .doc template. You are free to alter, add or delete any material you wish. DBI does not alter, add or delete provisions from the model template.

How to Start a Delaware LLC?

  • We would be happy to help you start your Delaware LLC. We can help you select your company name, reserve your company name, prepare your articles of formation, and file the certificate with the State of Delaware.

 

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