A limited liability company, or LLC, is a hybrid business structure that is legal everywhere in the United States. An LLC offers some of the advantages of corporations, like limiting legal liability, but relatively few of the disadvantages like double taxation. However, state laws vary significantly regarding how and when LLCs are dissolved, and in some cases ...require the dissolution of the entire LLC if any one member leaves.
Articles of Organization and Operating Agreement
The Articles of Incorporation details the name, purpose, duration, and identities of the members of an LLC, and is filed with the Secretary of State's office. The operating agreement is similar to the bylaws of a corporation, and includes the specific rules for handling management decisions, transfer of interests, withdrawal of members and conditions for dissolution. It is important to consider both the relevant laws in the state where the LLC is being formed, and the tax consequences for members when structuring the conditions for transfers of interest, member withdrawals and dissolution.
Dissolution of the LLC
Most states allow the operating agreement to control the conditions for dissolution of an LLC, but a few states require that LLCs be dissolved under certain conditions regardless of the operating agreement, including when any one or more member(s) leaves. Assuming your LLC is in a state where the conditions for dissolution can be set by the operating agreement, it is important to specify that the LLC will not necessarily be dissolved with the departure of one member. The unexpected dissolution of an LLC can have significant tax consequences for all members, so it is preferred to have a planned dissolution that minimizes taxes.
Tax Consequences of Planned Dissolution
Although LLCs can opt for corporate tax status, the IRS allows LLCs to choose partnership status, and most do to avoid corporate double taxation. Furthermore, IRS regulations regarding partnerships allow them to be structured to minimize tax consequences, and setting up a tax-minimizing dissolution plan is an essential part of writing your initial operating agreement.
Tax Consequences of Unplanned Dissolution
The tax laws surrounding LLCs are quite complex, and some are designed to prevent members from avoiding taxes by switching ownership of assets to the LLC. Other laws are designed to make sure that appreciated assets are properly accounted for and taxed. However, all the laws really do is enforce waiting periods before members can receive distributions after making certain types of asset transfers to the LLC, so careful tax planning and timing of the distributions or the dissolution of the LLC is very important.