May 7, 2010
If You've Got The Money, Partner, I've Got The Time
If You've Got The Money, Partner, I've Got The Time Cliff Ennico www.creators.com #147;My wife is starting a limited liability company (LLC) with a friend. My wife will work in the business full time, while her partner will not. Her friend, however, is putting up a significant amount of cash for the business, which my wife can#146;t do. What is the fairest way to divide the ownership of the LLC in a situation like this?#148; This is a tough one, and you will need the help of a really good tax adviser because the LLC tax laws are very tricky. Here#146;s one possible way to set up the LLC, according to tax lawyer Joseph Sweeney of Fairfield, Connecticut ( joe_sweeney@att.net ): First, your wife and her friend will need to sign an Operating Agreement (similar to a partnership agreement) when they form the LLC #150; make sure this is drawn up by a good lawyer; The Operating Agreement should provide that for management purposes, your wife and her friend will always be 50/50 owners of the LLC #147;regardless of their respective capital accounts#148;; and The Operating Agreement should also provide that your wife shall be entitled to #147;up to $XXX#148; in compensation each year for her services to the LLC, #147;or such greater amount as shall be approved by 100% of the LLC members from time to time#148;. So, for example, if your wife is entitled to take up to $50,000 as compensation, and the LLC earns $75,000 in net income this year, your wife would take her $50,000 #147;salary#148;, and the $25,000 balance would be divided 50/50 ($12,500 each) between your wife and her friend. Your wife would report $62,500 ($50,000 + $12,500) as income on her tax return for 2005, and her friend would report the remaining $12,500. Because your wife has only 50% of the LLC membership interests, she will need to obtain her friend#146;s consent before making any major business decisions, and if the LLC is later sold or goes out of business, your wife and her friend would share the proceeds 50/50 after paying off the LLC#146;s debts. Another possibility: your wife and her friend could be 50/50 owners of the LLC for management purposes, but with a provision giving your wife #147;preferred distributions#148; instead of a salary over a period of time while the business is growing. Example: the LLC would agree to pay your wife 80% of the LLC#146;s profits instead of 20% until such time as the LLC#146;s annual profits reach a specified target amount (basically, an amount that will enable your wife to live on 50% of the profits). At that time, the #147;preferred distributions#148; (the additional 30% of profits paid to your wife) would cease and the two owners would share in all future distributions 50/50, the same as their management split. This arrangement may make sense if you have no idea how much money the LLC will make (i.e. whether or not there will be sufficient income to pay your wife a fixed salary) in the early years. Yet another possibility: have your wife be the sole owner of the LLC, and have her friend loan the money to the LLC. Your wife would promise to repay the loan over the next 10 years, with simple interest at 6% per annum (a good commercial rate right now, and easy to calculate) plus an #147;equity kicker#148; of X percent of the LLC#146;s net income each year. That will give her friend a share in the LLC#146;s success, and your wife will have sole control over the LLC#146;s business. However, this arrangement has some disadvantages, according to Sweeney: this arrangement might overtax the cash flow of the LLC in any given year; your wife#146;s friend will not enjoy any of the capital appreciation if the business is sold or liquidated; your wife#146;s friend will not enjoy a deduction for any losses the business may incur.; and if the business doesn#146;t succeed, the loan will be a writeoff for the LLC, triggering #147;forgiveness of indebtedness#148; income that would pass through to your wife, creating a nasty tax surprise for her (and you). Cliff Ennico ( cennico@legalcareer.com ) is a syndicated columnist, author and host of the PBS television series 'Money Hunt'. This column is no substitute for legal, tax or financial advice, which can be furnished only by a qualified professional licensed in your state. To find out more about Cliff Ennico and other Creators Syndicate writers and cartoonists, visit our Web page at www.creators.com . COPYRIGHT 2005 CLIFFORD R. ENNICO. DISTRIBUTED BY CREATORS SYNDICATE, INC. Permission granted for use on DrLaura.com

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