Wealthy & Wise: Biggest LLC Mistake

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About the Video: Wealthy & Wise: Biggest LLC Mistakes

One of the most common mistakes people make in business when forming an LLC (Limited Liability Company) is failing to properly separate their personal and business finances. This can lead to personal liability for the LLC’s debts and legal issues. Another mistake is not understanding the legal requirements and regulations for forming and maintaining an LLC, such as filing annual reports, paying taxes, and maintaining proper records. In addition, some people make the mistake of not having a comprehensive operating agreement in place, which can lead to disagreements and disputes among LLC members. Overall, it’s important to seek professional guidance and education to avoid these common LLC mistakes and ensure the success of your business.

Prefer to read? A full transcript is provided below.

Cort:

Hello and welcome to another edition of Wealthy and Wise. I’m your host, Cort Christie. And today we’re going to be talking about the biggest mistakes that you can make with an LLC. And I’m talking big mistakes. Problems. Issues. Things that if you do it wrong, you will not gain the benefit of the LLC. And not only that, it may cost you a lot of money in the end. And today we have a special guest. We have Adam Kintigh. Many of you have heard him, seen him. He hosts this show often. Adam is amazing. He’s here to educate all of us today. Adam, thanks for coming to the show today.

Adam:

Thank you for having me, Cort.

Cort:

Absolutely. So, the biggest mistakes with LLCs. You’ve worked with thousands and thousands of people. Offline, you were just telling us about one mistake. I know you see a lot of mistakes that happen and they’re very expensive. If you don’t get on them, aren’t aware of them, and it could be a big issue. So, let’s jump right in.

Adam:

So, you talk about the biggest mistakes, and I think the first thing is people that are short sighted in forming a company where the mistake is they thought they had an LLC, then they get sued or they get audited. And that’s a heck of a time to figure out that you weren’t even an LLC. Often people just form their Articles with the Secretary of State, and they stop right there. They don’t think about the fact that they have to have an operating agreement. They need membership certificates that, even if it’s just you, they have to be issued to show that you’re acting as a real person or a real legal entity. Not getting an EIN number. So, people often will either get an EIN number for the business or they’ll do it wrong. Where they get the EIN number, they don’t make the proper tax election. So, now tax time rolls around, it wasn’t done right. They’re paying all this extra money in taxes. I was just thinking about, most the time people are forming an LLC to separate themselves legally and to provide tax savings. Those are really the two biggest ones. But when they’re just starting a business, I understand people are bootstrapping. They want to get the least cost as possible, so they go the least cost route, and they form the company. And then find out later on business is going good three or four years down the road. The last thing on their mind is whether or not that LLC was done right. Accident happens, the attorneys subpoena their corporate record book and now what?

Cort:

It so interesting how you know there’s so many people, we’ll call them the DIYers the do it yourselfers. You know we don’t need to pay a company to take care of this for us. I know how to do this. I’m going to go to the Secretary of State and I’m just going to file the form. There you go. The form is filed. That’s it, I’m done. Look at my LLC. I got a piece of paper back, a charter from the state of Missouri or the state of New York and I’m good. And as you know, and every attorney out there that loves to sue business owners and the businesses themselves, they love it when you don’t follow all of those compliant steps that are so important. And, you know, I don’t think that gets reinforced enough because I look at the data on how many people are registering companies on their own versus using a service provider. And it’s great you can register a company on your own versus using a company like NCH to do everything for you. But you have to remember what is everything? You don’t know, what you don’t know. And so, you talk about a record book or what’s in a record book? You kind of went into it. But could you give us a little more color, like what is a record book?

Adam:

Yeah. So, the first thing is you have your operating agreement, your initial organizational minutes, and that points in authorizes you to sign legal documents, open a bank account, all the pieces that we need to get things started.

Cort:

It’s all paperwork.

Adam:

All a bunch of paperwork.

Cort:

Yeah.

Adam:

And aside from that, you have this record book. You should keep your documents organized in a nice professional record book issuing the membership certificates. So, inside that book, you have a membership ledger where you’re tracking who owns the company, whether you formed the company initially to you or you issue it to your trust or to your partner. That’s our Bible of who owns the company. And people oftentimes don’t even do that. So now again, they get sued, heck of a time to figure out that, yep, you’re missing some pieces here and that LLC is absolutely worthless.

Cort:

Huge mistake. Huge mistake. All right. What other mistakes?

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Adam:

Yeah. So going into business with partners and a huge mistake that people make is they form the LLC and they don’t have a buy/sell and partnership agreement. So, we go into business with normally friends and family members and people we love and trust. And either when the company is doing really well or doing really poorly, we always have big problems. So, what happens if you have to put more money into the business to keep it afloat and your partner can’t put the money in? Well, what’s our rule? Am I going to dilute their ownership or do I give them time to put some money in? How’s that going to look? Or a partner gets divorced or files bankruptcy? How is that going to affect the business? And oftentimes you have no idea what skeletons your partner might have in the closet that they don’t even know about. But as those things start unfolding and happening, that affects your business and having the right legal agreements in place with the LLC is so important. And that’s just a little thing that in the beginning, again, we’re bootstrapping. We don’t want to spend the extra money on the buy/sell and partnership agreement. But it is such a little thing that is so important that I try and remind all of my clients, if you’re going to do it, let’s do it right. Get the foundation in place so that we don’t have to worry about it. Hit the go button, set it all up properly, and then later on when there are problems, you really are protected, and you really do have the best legal and tax structure in place.

Cort:

And we all know what the divorce rate is in this nation, right? 55% nationally. And we know that with business partnerships what’s the divorce rate? 80%, 90% it’s very high. And actually, the more successful the business oftentimes, the higher the likelihood that you’re going to have problems with your partner. And you’d think it would be absolutely the opposite. You know, it would be when you’re struggling. And, you know, but if you’re making money and things are going good, why would you have arguments or disagreements? There are 100 reasons why. And so, I think it’s critical, people don’t think about this, critical that you already preplan your divorce just like you would if you were getting married for the first time and you had some assets. You’re going to preplan for your potential divorce in your marriage. You did the same thing in a partnership. Critical, so important. Adam, I know we could spend an hour with the horror stories and all the partnerships that didn’t work out that we know about. You struck a chord with me because I was just having a conversation with Kurt Harris, our attorney, last week. And we were talking about, you know, the impacts of divorces. And pretty soon all of a sudden you have two people that decided to bring their skills together and become partners in a business. And one of them gets divorced. Guess how many partners you have? You just added another one, now you have three partners. And you think, well, they’re not involved why would the spouse have any interest in the business? They automatically get an interest in the business the minute the divorce happens if they want to. Now, and you can negotiate that in your divorce settlement. But if they decide they want to own a piece of the business, they get the other portion and they get half of whatever that partner has. So, significant problem that there’s an easy remedy, as you just mentioned, that buy/sell agreement. But we could talk a long time about partner issues. What other issues that you identify, mistakes people make with LLCs?

Adam:

Comingling funds. So, when you formed this LLC, it is its own legal person. You own the company, you control the company legally, you’re not the company. And a huge mistake that people make is using their business account to pay personal bills or using their personal account to pay business bills. So, everybody in starting a business, we’re starting it, we formed the company from the date of incorporation forward is where we’re going to get our tax benefits. And depending if it’s passive income or active income will depend on how we structured things from a tax standpoint. But you should be doing just a simple monthly expense report. It doesn’t have to be fancy. It could be a spiral notebook or an Excel spreadsheet at the top of the page. January expense report four simple columns. Date, dollar amount, who you paid, a brief description of what it was for and keep your itemized receipts. In the event you get audited, and I just had this happen to a lady two weeks ago. She got audited and the IRS actually requested a copy of her record book. They wanted to see that it was put together properly and they wanted to see receipts. So, as going through this audit, they want to see itemized receipts. And people said, well, I have a business card. I put in all my expenses on a business card, and we’re good because I have a credit card statement. No, they want to see receipts. So, my thought is in starting the business, if you’re using your own cash or your own credit to pay a business bill, you are co-mingling funds, which is a huge no no. The IRS can disallow the LLC, lawyers can ignore the LLC and pierce the veil. So, with that in mind, just do a simple monthly expense report where you’re keeping track of the money that you’re spending. So, yes, I paid for that using my cash or my credit, but my LLC is going to reimburse me when it’s financially able to do so. So, co-mingling funds is a big problem, easily avoided if people understand how it works.

Cort:

But I think so many people don’t think about, hey, getting a Visa card for my business so I can use it to pay all my bills. And I’m going to tell you that, you know, you don’t have to have a credit card, but with a bank account, a business bank account, make sure you get a debit card. If you can get a credit card, of course, get a credit card so it doesn’t pull your cash right out of your bank account. But if you don’t have that option because of your credit issues or whatever else is going on with you, get the debit card for the account and make sure you use it. Now, some lady might be listening saying, well, I haven’t earned any money yet. Then my recommendation is to fund your LLC, put money in your LLC, therefore you can use the debit card from the LLC. So, all your expenses are in the name of the LLC, not in your personal name, where you’re getting reimbursed for expenses from your LLC. It’s way cleaner, neater, less likely that the IRS will disallow those expenses as well. That’s a great one, Adam. And again, these are like classic startup mistakes that happen all the time with our LLC owners. That’s a great one. What else you got?

Adam:

So, I just dealt with this last week where a client set up a Family Limited Partnership back in 1999 and back then, those were things that we did, Family Limited Partnerships as an estate planning tool, a protection tool, and he was to put his real estate in there. So, he formed his Nevada Family Limited Partnership, which is a fantastic move. He set up a Nevada C corporation to serve as a general partner, and for whatever reason, he decided in 2011 that he no longer would need to keep that in good standing. Well, the first mistake was that his Family Limited Partnership purchased a property in Florida, and he did not register appropriately with Florida. Well, it’s a huge problem because in the event of a lawsuit, you know, we do get the best legal protection forming the company in Nevada. But we have to register appropriately with the state or states that we’re operating in. And if we don’t, soon as a lawsuit comes up, the state of Florida for this case, they would not even recognize the fact that he has this FLP. He would be in huge, huge problems at that point. So, number one, not registering there appropriately. Two, he didn’t pay the renewal fees. So, now we’re in a pickle because he wants to sell the property. In order to sell the property, he’s got this company and I did a ton of research. I talked with the title company, how are we going to sell this properly? They said, well, we can pay the fees to reinstate this, which was thousands and thousands of dollars. So, if you don’t pay the renewal fees on time, we have a little penalty. If you wait, as time goes by, these penalties are huge. So, now we’re looking at $10,000 or more just to reinstate the one company. Then he’s got to reinstate the other company because they had two entities in this structure. So, it’s just costing him a fortune. So, keeping the renewals done, keep them up to date and obviously registering with the state that you’re doing business. If we’re going to operate in other states, it is so true that we get the best protection by setting it up in Nevada, but we have to register appropriately with the states we’re operating in.

Cort:

Big deal, and it’s a really big deal. A good friend of mine who lives in northern Nevada had a piece of land and he bought it 20 years ago. And finally, it had some value because the surrounding area started to move. So, he called me and said he has a problem, very similar story. And the cost was just tremendous here in this case. He’s getting ready to sell the property. He’s got a deal on the table and the title company is giving him a hard time. And the reason is, it’s not in good standing. The cost to bring it current, same scenario, was I think it was like $12,000, but the property was like a $50,000 piece of land, was going to cost him $12,000 to bring the corporation at that time current so that he could sell it. The title company would not allow him to sell the property until it was current. So, guess what he had to do, pay $12,000 because of all the late fees that were layered on top of it. It would have cost him a quarter of that if he had just paid the fees every year to keep it going. So those are shocking stories to me. I said to him, like, what were you thinking? You had a piece of land. Why did you let the business entity go delinquent? And he just never thought of the consequences, basically. It’s like, I don’t know when I’m going to sell the land. And I keep paying these fees every year and I’m just sitting on it, you know? And then all of a sudden he’s got an offer on the table and he regrets that decision. Same scenario. All right, what else do you have for mistakes?

Adam:

All right. So, my last big mistake that I have is when people form LLCs, they elect to be taxed as an S corp or you form an S corporation and you don’t pay yourself properly out of the company. So, the IRS has rules that if we’re an S corporation, we must take a reasonable salary from the business. And reasonable is typically no less than 30% of the net profit. That’s not a hard, fast rule, but normally no less than 30% as a W-2. The rest we pay you as K-1 distribution. And by doing it this way, you can save thousands and thousands of dollars in taxes. However, the payroll, the W-2s have to be done before December 31st. And oftentimes people run the business. They don’t take the proper W-2. So, tax time rolls around and they figure out that now they’ve got to go back. We’ve got to file some additional tax forms. They didn’t, they end up paying the full taxes as though they were a sole proprietor. So, they get none of the tax savings that they’re supposed to is technically what happens. So, making sure that we pay ourselves properly, set the payroll up, do the 1099 or the W-2s and the K-1 distributions and make sure you’re operating things properly. And remember, as a business owner, anybody that you’re going to pay $600 or more to throughout the year, you have the 1099 these people. So, you should be asking everybody that you are paying as a business owner, you should be asking for a W-9. So that when tax time rolls around, we have until every year from January 1st until January 31st, we have to get out the 1099s and I cannot issue a 1099 unless I have a W-9. So, critical mistake now getting the right tax documents in order, not paying yourself properly, it will catch up. And normally if you make a mistake, the IRS is not going to talk to you about that mistake or even notify you of a mistake usually for three or four years. Then you get the notice. hey, we got a notice here from 2018 that you didn’t do something properly. And by that time, most people have kept poor records and they end up in a very bad position. So, my rule is how long should you keep receipts? How long should you keep records, whether it’s a physical copy or electronic copy? My rule is seven years or forever, whichever is greater. Keep those receipts. There’s actually legislation as part of the Biden tax plan that would allow the IRS to go back 20 years. 20 years. Thank goodness it did not get passed as part of the tax bill, but that would have been a huge problem for a lot of people.

Cort:

20 years reach back, I can’t even imagine as a business owner. You think of the receipts that I do have in files from ten years ago. You can’t read the receipts anymore, you know, they’re all faded. What are you going to do? So, you pointed out some classic mistakes that people make with LLCs. And I’m sitting here thinking as a listener to this show today, Adam, about, you know, all the things that you have to do as a business owner. And there’s not a ton of compliance requirement, a ton of things that have to complicate your life. But there are some things you need to pay attention to, like, you know, getting your 1099s out and collecting the W-9s from people that you’re paying. And that could be contractors you’re paying, it could be the handyman you paid to do something, it could be a part-time employee. Whoever it is, you have to have records and you have to have the documentation that you actually paid them a fee, interesting enough. But, you know, just think of, it sounds daunting as a viewer right now, but it’s really simple. There’s just a few things you got to do right along the way. And when you have an operating company, not necessarily a company just to hold real estate and you’ve chosen to be an S elected entity, which is the most tax efficient type of way of being taxed that’s out there for an operating company. You have to make sure you pay yourself payroll. That means using an ADP or any other payroll provider just to make sure that you have something that shows a salary was being paid to. You can’t just wait till the end of the year and then just distribute it all to you in the form of payroll or profits or distributions, as you might think. Have your payroll set up along the way to do it right, once you start making money in your business. So, these are fantastic things to call out, point out to our small business owner audience or future small business owner audience that’s listening right now. Learning about some of the mistakes that people make and make sure you don’t fall into any of these traps. And if you’re concerned about something you’ve done, maybe that was wrong. We’re happy to talk to you. Even if you are not a client of ours or don’t intend to be a client. We’d love to have a conversation because we want to straighten people out, especially our small business community that we love so much. Feel free to call into NCH, ask us any type of questions we do not charge to answer questions. We love it when we can be on the phone talking to as many people as possible because we’re all about, you know, getting America back to work. We’re all about getting past all the implications on our economy of COVID. And really, we’re here to support the American dreams of entrepreneurship in this country. So, call us with any questions. We’re here to help you take advantage of all the services and offerings that we have as well. Again, Adam, thank you for teaching us today and sharing great information for all of our viewers.

Adam:

Thanks for having me.

Cort:

Absolutely. And thank you, all of you, for tuning in today to another edition of Wealthy and Wise. I’m your host, Cort Christie. Have a great day!

DISCLAIMER: The above material has been prepared for informational purposes only, containing opinions of the provider, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. Please consider consulting tax, legal, and accounting advisors before engaging in any transaction.

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