How to Form a Multi-Member LLC in California
To form your company, you need to file the proper documents with the state and make sure that you follow a few important regulations.12 min read
Understanding how to form a multi-member LLC in California is actually very simple. To form your company, you need to file the proper documents with the state and make sure that you follow a few important regulations.
Pick a Name
Before you start the process of forming your California multi-member LLC, you need to pick a suitable name for your company. You should spend some time researching potential names for your LLC. The name that you choose should help consumers understand the purpose of your company, and your LLC name should also be easily searchable.
The name you select for your company must contain an indicator of your status, meaning it should contain the words “limited liability company” or an abbreviation such as L.L.C. or LLC. California, like many states, places restrictions on certain words that you may wish to include in the name of your LLC, such as:
If you want to use one of these words, you will need to submit additional paperwork with the state. Also, you may need a professional, such as a licensed attorney, to become a member of your LLC. Words that indicate your LLC is affiliated with a government agency are prohibited and cannot legally be included in your LLCs name. These words include Treasury, Secret Service, and FBI.
Most importantly, your LLC name should be unique, meaning there is no way that the average person could confuse the name of your LLC with the name of another California company. After you settle on a name for your company, you should search the California Business Name Database to make sure the name you have chosen doesn't conflict with the name of another LLC. If you find that your desired name has already been registered, or if it is too similar to a registered name, you will need to pick a new name for your company.
If your name is available, you should reserve it so that no other company takes your name while you complete the LLC formation process. You may also wish to register a domain name for your company, even if you are not currently planning to launch a website for your company.
Choose a Registered Agent
In California, all multi-member LLCs are required to appoint a registered agent, which is a person or business designated to accept service of process on behalf of the LLC. Registered agents are also referred to as Agents for Service of Process.
Your registered agent will accept any legal documents that are sent to your company. Some of the documents your agent can accept include state filings and notifications that you are being sued. To be a registered agent a person or business must meet certain qualifications. If an individual wishes to serve as a registered agent, they must be a resident of the State of California. A business can serve as a registered agent, as long as it is legally allowed to conduct business in California.
While LLCs are not allowed to serve as their own registered agent, you can appoint an individual in your company to this role. Lastly, your registered agent's address cannot be a Post Office Box. Eligible registered agents must have a physical street address within California.
Initial Statement of Information
One of the most important requirements for forming a multi-member LLC in California is to file an initial Statement of Information using Form LLC-12. You must file your Statement of Information within 90 days of LLC formation. You should submit Form LLC-12 to the California Secretary of State, and you can file online, in person, or by mail. When filing your Statement of Information, you will need to pay a $20 filing fee, which is non-refundable.
Estimated Fee and Franchise Tax
Every LLC in California is required to pay an annual franchise tax of $800. This fee is required regardless of how much money your LLC has earned or whether your LLC is even active. You will need to pay your franchise tax to the California Franchise Tax Board instead of the Secretary of State.
You will need to use Form 3522 to pay your franchise tax. Form 3522 changes every year, so you should be certain to download the current version before attempting to pay your franchise tax. The latest franchise tax voucher is available on the Franchise Tax Board website.
The due date of your franchise tax will depend on when your LLC was formed and whether you use a fiscal year or a calendar year. Franchise taxes are due on the fifteenth day of the fourth month of your calendar year or fiscal year. If your LLC was formed on January 1st, for instance, you would need to pay your franchise tax on April 15th. If your LLC was formed on November 1st, meaning you use the fiscal year, your franchise tax would be due on February 15th.
If your gross annual income will be $250,000 or more, your LLC will also be required to pay an estimated fee. You will file Form 3536, along with the proper payment, to pay your estimated fee. As with Form 3522, Form 3536 changes every year, so you will need to download the latest version to pay your fee correctly.
A Guide to Forming a Multi-Member LLC in California
A California Limited Liability Company (LLC) is a business entity formed under the laws of the state of California. It similar to a partnership, providing management flexibility and the benefit of pass-through taxation. A multi-member LLC is owned by multiple people or "members." A standard practice is to have the members choose a single person or a group of people, called "managers," to run the organization. Forming a California LLC takes places in two stages.
You will first file your Articles of Organization with the California Secretary of State. This can take up to a week. Once you have successfully filed your Articles of Organization you can complete the remaining items in the same afternoon and sign them all simultaneously.
1. Decide On Each Member's Ownership Interest
There are a number of factors to consider when deciding on each members ownership interest: who will be working full time vs. part time, who is contributing the initial funding beyond the Membership Contributions and who is willing to put in more, to name a few.
One common mistake among early entrepreneurs is to give away too much ownership to people who have not taken as much risk as you have or sunk as much time and money into the company, explained well by entrepreneur and investor Mark Suster. As a general rule, DO NOT CREATE 50/50 OWNERSHIP SPLITS, explained by Rich Barton of Zillow on a great Geekwire article. There are some exceptions to this general rule, for example, if the members have a proven work history.
2. Choose The Manager or Board Of Managers
When you have more than one member owning interest in the LLC, it is advisable to have a manager or board or managers. These are the individuals that will run the company on behalf of the other members and will have the authority to bind the company. You do have to list your manager(s) in the operating agreement, but you should state in your operating agreement that the LLC will be manager managed.
3. File Executed Articles of Organization With the California Secretary Of State
The Articles of Organization are what you file with the California Secretary of State to form your new LLC. There are minimum requirements that need to be listed in the Articles of Incorporation in order for them to be accepted. The attached form is provided by the California Secretary of State and includes the minimum information which is required for the Articles of Incorporation to be accepted by the state (see page 3 for the actual Articles of Incorporation).
Complete the provided form and mail it to Secretary of State, Document Filing Support Unit, P.O. Box 944228, Sacramento, CA 94244-2280, along with the $70 fee. For completing the Articles of Incorporation, put the name of one of the founders and their address for the Agent For Service of Process. You will also check the box "Manager" or "More Than One Manager" under Section 5 since the LLC will be managed by a single or multiple managers.
4. Execute Multi-Member Manager Managed LLC Operating Agreement
An operating agreement is an agreement among limited liability company members governing the LLC's business, and member's financial and managerial rights and duties. LLCs operating without an Operating Agreement can be declared unformed.
An Operating Agreement is similar in function to corporate by-laws, or analogous to a partnership agreement in multi member LLCs. In single member LLCs, an operating agreement is a declaration of the structure that the member has chosen for the company and sometimes used to prove in court that the LLC structure is separate from that of the individual owner and thus necessary so that the owner has documentation to prove that he or she is indeed separate from the entity itself.
Limited liability companies are very flexible in nature and the operating agreement defines each member or manager's rights, powers and entitlements. This includes capital accounts, membership interest, distributions of profit and allocated tax responsibility, just to name a few. This internal document is an agreement set by the company members that contains provisions for critical items and rules that run the company. Operating Agreements can be amended at any time by the company members or managers.
5. Members Execute 83(b) Election for Ownership Interest With Vesting
Each member whose stock is subject to a repurchase option (vesting) should complete an 83(b) election and mail them into their nearest IRS office. In California mail to: Department of the Treasury, Internal Revenue Service, Fresno, CA 93888-0002. Founders of startups typically have vesting put on their founder stock.
As ownership vests, the IRS views this as additional income and you would normally be taxed on this. If the value of the interest that vests is large, then the member could be hit with a large income tax. Filing an 83(b) election allows you to recognize “income” upon the purchase of the membership interest. Since the purchase price for the membership interest and the fair market value are the same, the member would have to pay nothing if they properly filed their 83(b) election.
6. Each Member Executes an Intellectual Property Assignment Agreement
When forming a company it is important that each founder assign to the company all relevant intellectual property developed prior to the formation, as well as after the formation of the company. An intellectual property assignment agreement specifically deals with pre-formation inventions, though you can assign both existing and future inventions in one document as long as you make a "present assignment" (i.e., "I hereby assign" as opposed to "I agree to assign" which is a promise to assign in the future) of both types of intellectual property. You want to make a present assignment so that the company does not have to try to collect extra assignments down the road in litigation, so that anyone that buys your company doesn't have to ask for extra paperwork, etc. By executing an Intellectual Property Assignment Agreement in connection with the purchase of membership interest, you can assign all or part of your IP to the company.
If any of the Members have a patented technology which was developed for the company or that would be utilized by the company, they should assign it to the company. This should be done in a separate patent assignment agreement and have additional payment (consideration) attached to it. The other alternative is to have the patent holding member license the patented technology to the company. This is typically not a good idea. It puts the company at risk of potentially loosing key technology at some point in the future if that member departs. Investors are usually reluctant to invest in a company that does not own its key patents.
If any of the members have a relevant patent or trademark to assign to the company then they must assign them to the company. You should do this shortly after the execution of the Intellectual Property Assignment Agreement in step 4. These assignments can be made electronically with the Patent and Trademark Office at: Electronic Trademark Assignment System (ETAS): http://etas.uspto.gov/ and Electronic Patent Assignment System (EPAS): http://epas.uspto.gov/. It is a best practice to have in writing the assignment of a patent to the company, which is stored in the company records. The document attached here is that patent assignment agreement.
7. Each Member Records Patents or Trademarks Assignment
Every founder and employee should sign a Confidential Information and Invention Assignment Agreement. This agreement has two primary functions. First, this agreement implements confidentiality into the relationship between the founder and the company. Second, this agreement assigns to the company all of the intellectual property and work product related to the company that is developed by the signing individual while the person works for the company. This is different than the Intellectual Property Assignment Agreement seen above, which assigns company related intellectual property from BEFORE they were with the company.
8. Each Member Executes a Spousal Consent of Operating Agreement
In a community property state like California, a spouse will by default own 1/2 of the marital assets including any equity purchased with marital assets. Therefore, a spouse will almost always need to agree to the terms of the Operating Agreement as well. This can be done with a Spousal Consent. It is a good practice for each member to sign a Spousal Consent even if they are not married so they can acknowledge that they are not married. It is good for the company to know about all potential shareholders.
9. Make S-Corporation Election
One of the attractive, but often confusing, aspects to forming a limited liability company (LLC) is the flexibility of electing how the LLC and its owners, called "members," will be taxed. This flexibility exists because the federal government does not recognize an LLC as a classification for federal tax purposes. In fact, multi-member LLCs are often taxed as partnerships while single-member LLCs are taxed as sole-proprietorships. However, even though an LLC is not a corporation, it can choose to be taxed as one. When members of an LLC choose to be taxed as a corporation, the default is to be taxed as a C Corporation.
However, an election can be made to be taxed as an S Corporation. Being taxed as an S Corporation allows LLC members to take advantage of certain tax benefits not available to partnerships or sole-proprietorships while, at the same time, avoiding the "double taxation" concept of a standard C Corporation.
So, the question is, "Does it make sense for an LLC to be taxed as an S-Corporation?" In short, the answer to the preceding question has to do with money and how much of it the LLC makes. If the business of the LLC generates a nice profit over and above what would be considered reasonable compensation for the services that the owners provide, the LLC may be unnecessarily subjecting its profits to self-employment taxes.
This is because the profits of partnerships and sole-proprietorships are subject to self-employment taxes, which as of February, 2012, are 15.4 percent of profits (i.e., $100,000 profit is subject to $15,400 in self-employment taxes). Being taxed as an S-Corporation allows the LLC to pay its employee-members (i.e., those members who are actively working the business of the LLC) a wage in addition to the LLC's profit. This is a benefit because only the wage is subject to the self-employment tax while the profit distributed to the LLC member or members is not (NOTE: members who are not actively working the business will not qualify for payment of a wage; so S Corporation election is not likely to impact a passive member's tax liability).
More often than not, this results in a lower tax liability or "tax bill" for the members. The catch, however, is that the wage must be "reasonable," meaning that the wage cannot be too low. In order to determine whether a wage is reasonable, LLC members should consult with a tax attorney or CPA. It is important to note that in addition to paying LLC members a reasonable wage, there are other restrictions to the S Corporation election.
First, the LLC may not have members who are corporations, partnerships, or non-resident aliens. Second, the LLC may not have more than 100 members, and third, the LLC can only have one category of ownership (i.e., cannot have multiple categories of ownership such as voting and non-voting). For single member LLCs, meeting the above criteria usually is not a problem.
For multi-member LLCs, however, this criteria can be troublesome; so care must be taken to confirm, prior to making the election, that the LLC will qualify for S Corporation taxation. Electing to be taxed as an S Corporation requires filing a form 2553 with the IRS no more than two months and 15 days after the beginning of the tax year the election is to take effect, or at any time during the tax year preceding the tax year it is to take effect. This election is optional and to make the election with the highest level of confidence and clarity, the appropriate professional, such as an attorney and/or CPA, should be consulted.
10. Request EIN from IRS
Your Employee Identification Number (EIN) is your company's social security number or tax ID number. It allows you to get a bank account and is required to hire any employees. An EIN can easily be obtained online (Monday - Friday: 6:00 a.m. to 12:30 a.m. Eastern time and Saturday: 6:00 a.m. to 9:00 p.m. Eastern time) One of the managers can get the EIN in less than 10 minutes. He will need his Social Security number and the filed Articles of Organization with the assigned California entity # printed on the articles.
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