Organizing an Illinois Limited Liability Company

Organizing an Illinois Limited Liability Company

WILLIAM A. PRICEAttorney at LawWarrenville

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I. [3.1] Introduction

II. Choice of Entity: Industry, Tax, Liability, Control, and Distribution Issues

A. [3.2] For-Profit and General Nonprofit Business and Other Organization TypesB. [3.3] Types of Business Operation, Industry Norms, and Tax Questions

1. [3.4] Sole Practitioner of Law2. [3.5] Two Investors3. [3.6] Software Company4. [3.7] Corporate Group

III. Organizational Filings and Forms Needed

A. [3.8] LLC Organization and Tax RegistrationB. [3.9] Regulated Entity Compliance CertificatesC. Not-for-Profit Organizations

1. [3.10] Charitable Trusts Registration and Reporting2. [3.11] Religious Organizations

D. [3.12] Tax Exemption1. [3.13] Federal Income Tax Exemption

a. [3.14] Religious Organization Exemptionsb. [3.15] Political Organization Exemptions

2. [3.16] Sales Tax Exemption3. [3.17] Property Tax Exemption

E. [3.18] Local Registration and Permits

IV. For-Profit Entity Tax Incidence

A. [3.19] Tax PlanningB. [3.20] Federal and State Income TaxC. [3.21] Filings Needed To Obtain Specific Federal Tax TreatmentsD. Status Available Without Election Filings

1. [3.22] Disregarded Entity2. [3.23] LLC Taxed as a Partnership3. [3.24] Limited Partnership LLC

E. [3.25] Entity Status Requiring Election or IRS Qualification Decisions1. [3.26] S Corporation Status2. [3.27] C Corporation Status3. [3.28] LLCs Pay No Illinois Franchise Tax

V. [3.29] Self-Employment Tax

A. [3.30] Self-Employment Tax RatesB. [3.31] Self-Employment Regulations Applicable to a Limited Liability Company or

Other Organization Taxed as a PartnershipC. [3.32] Use of LoansD. [3.33] Use of a C CorporationE. [3.34] Use of an S CorporationF. [3.35] Combined ElectionsG. [3.36] Other State and Local Taxes

VI. Liability Limitation

A. [3.37] Statutory ProtectionB. [3.38] Risk Management

VII. Control and Management

A. [3.39] ControlB. [3.40] ManagementC. Distributions

1. [3.41] Distributions in the Ordinary Course of Business2. [3.42] Distributions on Dissolution

VIII. [3.43] Pre-Organization Agreement

IX. [3.44] Reservation of Name

X. Articles of Organization

A. [3.45] In GeneralB. [3.46] Filing Form LLC-5.5

1 [3.47] Question 1 — Limited Liability Company Name2. [3.48] Question 2 — Address of LLC’s Principal Place of Business3. [3.49] Question 3 — Date That Articles of Organization Are Effective4. [3.50] Question 4 — Registered Agent’s Name and Registered Office Address5. [3.51] Question 5 — Purposes for Which LLC Is Organized6. [3.52] Questions 6 and 7 — Dissolution7. [3.53] Question 8(a) — Management by Managers8. [3.54] Question 8(b) — Management by Members9. [3.55] Question 9 — Affirmation

10. [3.56] Other Provisions for Regulation of Internal Affairs of LLC11. [3.57] Transacting Business Under Assumed Name

XI. Tax Registration

A. [3.58] Unemployment InsuranceB. [3.59] Business Tax Registration

XII. Appendix

A. [3.60] Pre-Organization AgreementB. [3.61] LLC Operating Agreement — Simple Form, Member-ManagedC. Additional Resources

1. [3.62] Bibliography2. [3.63] Internet Resources

I. [3.1] INTRODUCTION

As the attorney responsible for organization and operations counseling in a new business venture, counsel must consider more than the minimum legal requirements for filling in the blanks on limited liability company (LLC) organization forms. First and foremost, company legal counsel may be the only experienced business professional a startup entrepreneur consults. Moreover, counsel is often brought in considerably after actual business operations have started. Also, the clients who seek counsel may not excel in organization outside their own fields of specialization. Counsel, therefore, should take care to provide information on all appropriate business and legal/liability protection considerations relevant to the business, as well as the initial and continuing state, federal, and local government filings and compliance requirements affecting the enterprise.

II. CHOICE OF ENTITY: INDUSTRY, TAX, LIABILITY, CONTROL, AND DISTRIBUTION ISSUES

A. [3.2] For-Profit and General Nonprofit Business and Other Organization Types

For-profit business organizations are not the only types of entities that may be organized as limited liability companies or other varieties of associations defined by statute. Not-for-profit entities, for-profit corporations, business trusts, limited partnerships, and (in some states) limited liability limited partnerships each come with their own tax treatment, degrees of liability protection, forms of organizational control, and rights to distributions. Organizational counsel often need to assist clients as they make a choice among the various types of entities, usually with very little time to compare and consider complicated explanations. At the startup stage, clients also do not want to spend much money on entity research or explanations of comparative benefits and drawbacks. They just want a business formed — now — so they can do their deal.

With all the world to choose from and every state in the Union at least somewhat different in its organizational and liability laws, how should counsel and their clients choose appropriate forms of organization? Where should they organize? When should their choice of organizational form change?

The answers to these questions will be as variable as the markets, investors, stage of growth, and business plans of the client organization.

Lawyer use of LLC’s: Liability only partly limited: An individual or group organizing a professional law practice, for example, may will not be permitted to limit his or her or their liability for professional errors and omissions to amounts invested in the venture, although other business debts may be limited. Cf. Illinois Supreme Court Rule 721(d), which reads: “[T]he articles of incorporation or association or organization, or the partnership agreement, shall provide . . . . that all shareholders, members, or partners shall be jointly and severally liable for the acts, errors, and omissions of the shareholders, members, or partners, and other employees of the corporation, association, limited liability company, or registered limited liability partnership, arising out of the performance of professional services by the corporation, association, limited liability company, or registered limited liability partnership.” See generally Annot., 4 A.L.R.3d 383 (1965), cited in Alan R. Bromberg and Larry E. Ribstein, LIMITED LIABILITY

PARTNERSHIPS AND THE REVISED UNIFORM PARTNERSHIP ACT, p. 249 n.74 (1996). This answer applies, of course, to use of professional service corporations or other business entity types, as well as LLC’s.

Venture-Backed Startups: An organization that plans to raise investment capital through venture capital funds will have to consider corporation form in order to avoid the incidence of unrelated business income tax by not-for-profits that are major investors in such funds. See generally Constance E. Bagley and Craig E. Dauchy, Ch. 8, Venture Capital, THE ENTREPRENEUR’S GUIDE TO BUSINESS LAW (11th ed. 1997). These entities are not subject to the unrelated business income tax on dividend income, but might be so taxed on income from entities taxed as partnerships, such as LLC’s.

Publicly Traded Companies: A publicly traded organization, whether in partnership or corporation form, is likely to be subject to double taxation on organizational income unless it derives more than 90 percent of its income from real estate, natural resources, or other qualifying sources under U.S. tax law. See generally Code §7704. Several exceptions can be found, however, such as the exception to double taxation provided by a publicly traded real estate investment trust (REIT) or a two-layer investment, such as a venture capital partnership, which takes in limited partners that are pension funds and uses such pension funds as pass-through entities with members of the public as their investors. Elimination of double taxation is one of the major benefits usually sought by organizers of LLC’s.

B. [3.3] Types of Business Operation, Industry Norms, and Tax Questions

The charts below compare the various types of organizations required to file with state authorities and show their tax, liability, and management characteristics as well as those of sole proprietorships and business trusts, which are the other major business forms used in Illinois.

Table: Sole Proprietorships and Partnerships

Legal Forms of Operation Compared: Sole Proprietor and Partnerships

Sole Proprietor

General Partnership

Limited Partnership

Limited Partnership (Foreign)

Registered Limited Liability Partnership

Limited Liability Limited Partnership (Foreign)

Filing required to form or operate

None None SOS Business Services

SOS Business Services


None if full faith & credit, RLLP if want Illinois statutory protection

Formation None (local assumed business name may apply)

None (local assumed business name may apply)

SOS Form LP 201 SOS Form LP 902 SOS Form UPA 1001

SOS Form UPA 1102

Filing fees, minimum tax

None None $150; expedited: add $100; online: credit card fee (varies)

$150; expedited: add $100; online: credit card fee (varies)

$100 per partner; minimum $200, maximum $5,000)

$500

Annual filing fee or capital tax

None None SOS Form LP 210; $100; expedited: add $50

SOS Form LP 210; $100; expedited: add $50

SOS Form UPA 1103(D); No fee, no expedited service; Note: Form UPA 1101(h)/1101(g) is required if amendments: Fee $25;

SOS Form UPA 1103(f); $300, no expedited service; Note: Form UPA 1101(h)/1101(g) is required if amendments: Fee $25

Liability None None General Partner(s) General Partner(s) Partners limited Partners limited to

protection none; Limited Partners limited to investment amount

none; Limited Partners limited to investment amount

to investment amount

investment amount

Multiple ownership classes allowed?

Not possible Yes Yes Yes Yes Yes

Management Self General Partners (per partnership agreement)

General Partners (per partnership agreement)




Apparent authority to bind entity in contract

Self General Partners (or per agency filing)

General Partners (or per agency filing)




Legal Forms of Operation Compared: Sole Proprietor and Partnerships (cont.)

Sole Proprietor

General Partnership

Limited Partnership

Limited Partnership (Foreign)

Registered Limited Liability Partnership

Limited Liability Limited Partnership (Foreign)

Personal property replacement tax

None 1.50% of net income(all partner income except guaranteed payments)

1.50% of net income(all partner income except guaranteed payments)




Federal/state entity level income tax

No No No No No No

Table: Limited Liability Companies

Legal Forms of Operation Compared: LLCs

Limited Liability Company (Domestic)

Limited Liability Company (Foreign)

Limited Liability Company (Not-for-Profit)

Low-Income LLC Limited Liability Company (Series)







Formation filing fees and minimum tax

SOS Form LLC 5.5: $500; expedited: add $100; online: credit card fee (varies)

SOS Form 45.5: $500; expedited: add $100; online: credit card fee (varies)

SOS Form LLC 5.5: $500; expedited: add $100; online: credit card fee (varies) (IRS NFP language neededmust be in Articles of Organization to qualify for Fed tax exemption)

SOS Form LLC 5.5: $500; expedited: add $100; online: credit card fee (varies) (special language needed for IL statutory)

SOS Form LLC 5.5(s): $750; expedited: add $100; online: credit card fee (varies)


SOS Form LLC 50.1; $250; expedited: add $50; online: credit card fee. Member liability limited to investment amount.

SOS Form LLC 50.1; $250; expedited: add $50; online: credit card fee. Member liability limited to investment amount.

SOS Form LLC 50.1; $250; expedited: add $50; online: credit card fee. Member: no liability; limited for officers/directors if not paid salaries.

SOS Form LLC 50.1; $250; expedited: add $50; online filing allowed: credit card fee. Member:no liability no liability; limited for officers/directors if not paid salaries.

SOS Form LLC 50.1; $250; expedited: add $50. No online filing. Member liability limited to investment amount.

Liability protection Yes Yes Yes Yes YesMultiple ownership classes allowed?

Members and/or managers (per operating agreement)





Management Members or Managers

Members or Managers

Members or Managers

Members or Managers

Members or Managers

Apparent authority to bind entity in contract

Members or Managers (see articles of organization)

Members or Managers

Members or Managers

Members or Managers

Members or Managers


1.50% of net income(all member income except guaranteed payments)


None (1.50% on unrelated business income )



Federal/state entity level income tax

No No No (yes on unrelated business income)

No No

Table: Corporations and Other Corporate Entities

Comparison of Corporate entities

Corporation (Sub S Election)

Corporation (Sub C Election)

Corporation (Foreign) Corporation (Sub S), (Foreign)


SOS Business Services and IRS election

SOS Business Services SOS Business Services SOS Business Services

Formation filing fees and minimum tax

SOS Form LLC 5.5BCA 2.10, $150 plus franchise tax ($25 min.); : $500; expedited: add $100; online: credit card fee (varies)

SOS Form LLC 5.5: $500BCA 2.10, $150 plus minimum franchis tax of $25; expedited: add $100; online: credit card fee (varies). File IRS 2553.

SOS Form BCA 13.15: $150 plus minimum franchise tax of $25; expedited: add $100; online: credit card fee (varies). Registration in home state also required.

SOS Form BCA 13.15: $150 plus minimum franchise tax of $25; expedited: add $100; online: credit card fee (varies). Registration in home state also required.


SOS Form Domestic Corporation; Annual Report Fee $75 plus franchise tax (minimum $25 maximum $2 million, 0.001 times stated capital)

SOS Form Domestic Corporation; Annual Report Fee $75 plus franchise tax (minimum $25, maximum $2 million, 0.001 times stated capital)

SOS Form Foreign Corporation Annual Report Fee $75 plus franchise tax (minimum, $25 maximum $2 million, 0.001 times stated capital). Also home state fees/tax.

SOS Form Foreign Corporation Annual Report Fee $75 plus franchise tax (minimum $25, maximum $2 million, 0.001 times stated capital). Also home state fees/tax.

Liability protection Shareholders limited to investment amount

Shareholders limited to investment amount



Multiple ownership classes allowed?

No Yes Yes No

Management Board of Directors Board of Directors Board of Directors Board of DirectorsApparent authority to bind entity in contract (see articles of organization)

President President President President


2.50% of net income 2.50% of net income 2.50% of net income 2.50% of net income

Federal/state entity level tax

No Yes Yes No

Net tax by entity type depends on minimum salaries required and individual income vs. capital gains rate, as well as entity level tax. Will change for 2011 tax year, depending on repeal or lack of same for Bush presidency capital gains rates, individual tax rates.

Comparison of Corporate entities (cont.)

Corporation or other Entity (Alien)

Business Trust (Foreign or alien)

Corporation (Not for Profit) Corporation (Not for Profit), Foreign


SOS Business Services and federal alien agent registration

None (see home state/country law); fed foreign agent if alien entity

SOS Business Services and AG if Charitable Trust Act Applies

SOS Business Services and AG if Charitable Trust Act Applies

Formation filing fees & min. tax

SOS Form BCA 13.15 $150 plus min franchise tax of $25 If expedited add $100 and if online credit card fee (varies) Registration in home country also required

None (Local Assumed Business Name May Apply)

SOS Form NFP 102.10 $50 If expedited add $25 and if online add $2.75 payment processing fee

SOS Form NFP 113.15 $50 If expedited add $25 No online filing


SOS Form Foreign Corporation Annual Report Fee $75 plus franchise tax (min. $25 max $2 million, 0.001 times stated capital) Also home state fees/tax

Home state/country forms and fees, if any

SOS Form C 54 NFP Annual Report Fee $10 Expedited fee $25 plus credit card fee if filed online

SOS Form C 54 NFP Annual Report Fee $10 Expedited fee $25; No online filing available

Liability Protection Liability limited by home state law; Illinois full faith & credit should recognize

Member no liability; Limited for officers/directors if not paid salaries

Member no liability; Limited for officers/directors if not paid salaries

Multiple Ownership Classes Allowed?

Yes Yes Yes

Management Trustee(s) Board of Directors Board of DirectorsApparent authority to bind entity in Contract (See Articles of Organization)

Trustee President President

Personal Property Replacement Tax

2.50% of net income 1.50% of net income None (except unrelated business income 2.5%)

None (except unrelated business income 2.5%)

Federal/State Entity Level Tax

Yes No No (Yes for unrelated business income)

No (Yes for unrelated business income)

The primary determinant of the legal form of organization that the clients and their investors or contributors will expect depends to a large extent on the industry in which the company will operate. This is usually a combination of custom and tax, liability, or other advantages. For instance, most hospitals are nonprofit organizations, which allows them to be managed by salaried professionals who do all the work doctors do not want to take on. The hospitals get income, sales, and property taxation breaks if their work is sufficiently charitable. Lawyers and accountants, by contrast, are responsible for each other’s work and so practice in partnerships, limited liability companies, and professional corporations that allow mutual control to those who produce income, i.e., the licensed professionals. Corporate real estate holdings are normally set up as real estate investment trusts, which limit liability for such assets that otherwise might spill over from high claims fields like construction or demolition. A federal tax advantage also eliminates entity-level tax for real estate investment trusts that pass enough of their annual income on to their owners. Industries develop and test common sets of forms, usual and customary billing and accounting methods, and functional corporate relations. These may change

over time, but the “right answer” tends to fall into patterns similar to those chosen by others in similar lines of business.

(3.4) For-Profit or Nonprofit Purpose Permitted For Illinois LLC’s

Note that §1-25 of Illinois’ Limited Liability Company Act (LLCA), 805 ILCS 180/1-1, et seq., permits LLCs to be organized for “any lawful purpose” (with a few provisions for regulatory compliance for any licensed profession or occupation and, in some cases, ownership restrictions to practitioners of the particular licensed profession for LLCs that are to carry out functions associated with insurance, dentistry, law, and medicine), so LLCs can be adapted to any of these industries, as well as to various tax-exempt purposes.

(3.5) Client Organizational Issues, By Size of Business

The following are reasonable organizational concerns for nonpublic organizations of different types at different stages of business growth:

1. liability limitation;

2. federal tax minimization;

3. administrative cost reduction (i.e., filing, legal, and bookkeeping fees to maintain the entity); and

4. foreign investor needs (restricted from investment in S corporations).

Other criteria may be more significant, however, particularly in states where local franchise taxes or high LLC filing fees may impose significantly different costs for alternative organizational forms. Note the significance of employment tax in the choice of entity advice given, as well.

(3.6) Securities Registration and Liability

For some deals, securities registration liabilities and costs may be significant. The court in Keith v. Black Diamond Advisors, Inc., 48 F.Supp.2d 326 (S.D.N.Y. 1999), held that LLC interests can be securities. The Keith court applied the Howey test (see Securities & Exchange Commission v. W.J. Howey Co., 328 U.S. 293, 90 L.Ed. 1244, 66 S.Ct. 1100 (1946)); i.e., an interest is a security if the individual purchasing the interest depends primarily on the efforts of others to make money.

Sections 3.74 – 3.107 below discuss typical circumstances and the forms of organization most likely to satisfy the client’s needs. A final note on taxes may help make the choice. Every form of tax treatment (nonprofit, pass-through, S corporation, C corporation for federal income tax; sales or property tax exemptions for state tax) can be available to entities formed as LLCs. The rest of this chapter assumes the choice of an LLC instead of some other form of entity.

1. [3.74] Solo Practitioner of Law

For a sole practitioner of law, sole proprietorship would likely be the best form of organization.

Liability limitation. Entity organization would not be significant for professional errors and omissions, as these would all be that of the individual, or for most business debts, as bank loans and real estate leases require individual guarantees. If general creditor debts are avoidable and dissolution is possible, there may be some benefit to the limited liability form, as long as initial and continuing capitalization is sufficient. Good insurance might be enough, however, and there is a state entity-level tax of 1.5 percent for all non-guaranteed distributions.

Federal tax. The entity would be disregarded under the “check-the-box” rule if it is not a corporation. See Treas.Reg. §301.7701-2(c)(2). Double taxation of income is unlikely to provide any benefits. As an owner of more than 2 percent of a corporation, the individual would have available a medical insurance deduction, but all distributions for it would be taxed to the individual, as they would in a partnership. Code §1372; Rev.Rul. 91-26, 1991-1 Cum.Bull. 184.

Administrative costs. Sole proprietorship requires only bookkeeping for an IRS Schedule C, Profit or Loss From Business, which is estimated to cost $500 or more per year if an outside accountant sets up the initial chart of accounts and reviews the return. Tax reporting for a separate entity will require additional bookkeeping and tax preparation, which would result in an opportunity cost if done by the sole practitioner or a cost of $1,000 or more if an outside accountant is hired. Organizational filing fees would also add to administrative costs.

Growth needs. The capital gains tax on conversion to corporation form is unlikely to apply as professional corporations are limited to investments by attorneys, so a closely held entity tax pattern (usually a partnership) is likely to apply.

Foreign country individuals or organizations. The relevant level of tax varies by tax treaty. The United States may allow reciprocal admission.

2. [3.85] Two Investors

For two investors purchasing a condominium unit intending to share investments, costs, and revenues equally and to sell the unit on agreement or as soon as investments qualify as long-term capital gains, the best choice for form of organization is likely to be a limited liability company.

Liability limitation/management. Significant capital in the property would make a liability shield against slip-and-fall claims by invitees of tenants or subcontractors on a build-out possible without piercing the corporate veil exposure and other similar claims. See generally Sarah Spear, The Limited Liability Company: The Importance of Choosing the Correct Business Vehicles (June 2006), www.llrx.com/features/llc.htm; Charles W. Murdock, Limited Liability Companies in the Decade of the 1990s: Legislative and Case Law Developments and Their Implications for the Future, 56 Bus.Law. 499 (2001). This makes cotenancy unattractive, though that would not carry 1.5-percent personal property tax replacement tax (2.5 percent for separate S corporations). These factors indicate an LLC or S corporation form, rather than such forms as a limited partnership, which would limit management of one partner. Registered limited liability partnerships (RLLPs) are not available in all states for limited liability partnerships and therefore might not be recognized in other states’ courts for tort claims by their citizens, if they rent condominium time.

See generally William Callison, Limited Liability Partnerships and Limited Liability Limited Partnerships, www.lectlaw.com/files/buo04.htm. General partnership would not shield owners from liability.

Federal tax. Adopting the partnership form will avoid double taxation of income, not only when earned but also on distribution. Active management of assets by both investors can prevent passive activity loss limits and allow losses (if any) to be offset against other investor income. Cf. Larry E. Ribstein and Peter V. Letsou, BUSINESS ASSOCIATIONS, pp. 268 – 269 (Matthew Bender & Co., 4th ed. 2007). See also Code §469 (passive activities). Separate ownership as tenants in common would provide similar benefits.

Administrative costs. Separate organization will impose costs for separate tax return preparation, which would be avoidable if the asset were held by tenants in common, in which case only individual IRS Schedule C filings would be necessary. See Code §761(a); James A Nepple, What Are the Tax Aspects Relating to Limited Liability Companies?, Illinois State Bar Association Law Ed Series, p. 17 (Sept. 25, 1998). Delaware or other out-of-state LLC organization would add expense. Organization in a state where the operations are intended will eliminate the need to pay both state-of-operation and state-of-organization filing fees. The Illinois Limited Liability Company Act is a good, general-purpose LLC statute, so local organization is not a significant disadvantage.

Growth needs. If the investors plan a series of real estate investments, partnership tax elections for the LLC and the ability to set up different classes of ownership for each new deal would still permit growth. Such investments are typically cashed out from time to time, making the realization of gain at the time new investors are brought in less of a penalty than would be realized for recapitalization of a growth business. Even if the organization were continued, reorganization of the partnership form would not necessarily incur immediate recognition of gain or loss in the way a distribution to partners, a conversion to a corporation, or a new LLC (new series in a series LLC) for each new deal would. Cf. Prop.Treas.Reg. §105162-97 (Oct. 27, 1997), cited in Nepple, p. 21.

Foreign country individuals or organizations. The LLC form would permit partnership taxation rules on distributions to individuals. Organization income streams may be characterized as corporation income (double taxed) or as partnership income (flow through to foreign entity investors according to foreign country’s own tax rules), depending on the organization type. Treas.Reg. §301.7701-2 (b)(8) generally treats organizations equivalent to U.S. publicly traded corporations as corporations and others as partnerships unless they elect business association status under U.S. law. Foreign country organizations and nonresident alien individuals are not permitted owners for S corporations, so the LLC form may be preferred if the investors fall into this class of taxpayers. See Ribstein and Letsou, supra, p. 274.

3. [3.96] Software Company

For a software company with a patent on key new technology that is ready for an angel investment of $800,000 (10 investors at $80,000 each), the choices for forms of organization would be a C corporation, if reasonably certain to proceed to venture funding, or a limited liability company taxed as a partnership.

Liability limitation. Angel investors will require limitation of their liability to the amount of their investments in the organization and typically are interested in being able to throw out management that fails to perform. This implicates the corporation or LLC forms, not the more passive investor styles provided in limited partnerships or business trust forms (the last is not a native Illinois business type in any case). The general partnership and registered limited liability partnership forms would be equally unacceptable, given full or partial exposure of investor assets to business debts and the high filing fees of a RLLP.

Federal tax. Partnership tax status would be preferred for organizations not likely to need to convert to a C corporation. Note, however, that venture capital organization is a likely means of cashing out initial investors for fast growth businesses. Because venture capital organizations usually need to invest in C corporations to avoid unrelated business income tax incidence on distributions through them to their not-for-profit investors (Constance E. Bagley and Craig E. Dauchy, THE ENTREPRENEUR’S GUIDE TO BUSINESS LAW (11th ed. 1997)), conversion of partnerships in which they invest to C corporations before or at the time of venture capital investment is a distinct possibility. With share valuations likely to increase significantly at each funding stage because more research and market testing are done at each stage, allowing the company to support a higher valuation at each successive financing, potential capital gains liability on conversion would be substantial. Founders and investors usually prefer to defer recognition of such gains until they have a public market for their shares.

Administrative costs. At these capitalization levels, the elimination of state franchise taxes may well offset any initial or continuing high organization fees, when investors come from states with such taxes (such as Illinois). The practical requirements of avoidance of investor mistrust and potential securities law liability under antifraud clauses of federal law and state blue-sky laws, even without public registration, will require CPA certification of accounts. The deal is also sufficiently large to support specifically tailored investor-company agreements and buy-sell arrangements.

Growth considerations. The tax needs of investors in institutionally managed funds (to avoid passive source income) outweigh those of friends and family and angel stage investors, as these deals have to mature fast or die.

Foreign country individuals or organizations. Neither class of investor is restricted from owning interests in U.S. corporations or LLCs.

4. [3.107] Corporate Group

Assume a corporate group with a variety of new technology projects, funded in part by a “cash cow” organization and burdened with a subsidiary with potential Superfund site cleanup liability. No excess of liability over capitalization of the subsidiary is anticipated, but total liability is uncertain. The likely choice for a form of organization would be a corporate parent with limited liability company subsidiaries or spinoffs for early stage investment in new technology ventures. Use a business trust or spinoff for the Superfund-burdened subsidiary.

Limited liability. The corporate parent and cash cow/technology venture combination would be burdened for the period of Superfund liability determination with significant attorneys’ and accountants’ annotations to financial reports on group performance, based on the liability

amounts, and with the duty (present in federal and state securities laws) to make disclosure of all facts that could be material to an investment in the venture. Failure to make such a disclosure can give rise to a finding of securities fraud. See 17 C.F.R. §240.10b-5. Absent undercapitalization or other grounds for piercing the corporate veil, separation of the Superfund-burdened subsidiary by transferring it to a business trust with trustee duties — including winding up the claims, operating the subsidiary until such claims are resolved, and either winding up the organization or reconveying the organization to the corporate parent once all claims are resolved — would eliminate potential charges on the corporate parent. LLC subsidiaries, like corporate subsidiaries, would shield the parent from liability beyond amounts invested in the subsidiary. Such liabilities can be significant when new and potentially overlapping technologies are involved.

Federal tax. The separation of the Superfund liability subsidiary will not save taxes because business trusts are subject to tax on business operations. If the spinoff were made irrevocable, the organization could realize an immediate capital loss to set off against gains from the cash cow/technology components of the group.

Technology or other small-growth components present an interesting tax opportunity. They can be separated into units small enough to be privately placed, with securities not traded on national or local markets, but with contract and other rights associated with the corporate parent. Cash flow from the LLCs can be directed to investors and to reinvestment in technology venture growth, with the parent having a controlling share and thus the right at 50.1 percent, instead of 80 percent or more, the requirement for the dividends-received deduction under the definition of controlled group organizations to avoid tax at the subsidiary level on dividends directed to the parent. Any LLCs organized as wholly owned subsidiaries could simply be disregarded for federal tax purposes. Treas.Reg. §301.7701-2(c)(2). They would still protect the corporate parent from patent and other claims against the new venture, based on the liability protections provided for LLC investors under state law.

Administrative costs. Once an organization has established the accounting and legal staff to manage more than one company, additional subsidiaries do not provide excessively large amounts of additional administration. Savings in franchise taxes and other state fees (as trusts do not require the same level of filing) by use of LLC and trust forms may be of some marginal benefit. Elimination of the $2,000 – $3,000 per year or more of additional accounting costs associated with auditing a separate set of books and submitting separate tax returns for wholly owned subsidiaries could save substantial amounts if no use of such forms for tax savings to investors is needed.

Growth considerations. In investments, growth tends to produce additional capitalization. When the growth components of an organization can be united with positive cash flow elements and given some tax advantage, the corporate counsel has contributed value to the organization.

Foreign country individuals or organizations. If the technology ventures involve out-of-country participants, they can be structured as joint ventures through LLC subsidiaries, without tax incidence to each partner at the subsidiary level. Appropriate contracting and operations locations can make income streams to the partners payable in the nation of organization, which may help to avoid additional potential for multiple taxation on single-source incomee.

C. (3.11) State Tax Planning.

Organizations that operate in multiple states can sometimes locate sales offices in states like Oregon, without sales tax, and home offices in states, like Delaware, Nevada, and Wyoming, that impose no income tax on out of state operations. (See generally 2009 State Tax Handbook, CCH, ISBN 9730808019213 (hereafter "CCH") or later editions, or All States Handbook, 2010 Edition, RIA Thomson, ISBN 978-0-7811-0415-9 ("RIA") or later editions.)

The general federal standard for income tax allocation is expressed in 15 USC § 381 - Imposition of net income tax (Ref current to Pub. L. 112-238):

(a) Minimum standards

No State, or political subdivision thereof, shall have power to impose, for any taxable year ending after September 14, 1959, a net income tax on the income derived within such State by any person from interstate commerce if the only business activities within such State by or on behalf of such person during such taxable year are either, or both, of the following:

(1) the solicitation of orders by such person, or his representative, in such State for sales of tangible personal property, which orders are sent outside the State for approval or rejection, and, if approved, are filled by shipment or delivery from a point outside the State; and

(2) the solicitation of orders by such person, or his representative, in such State in the name of or for the benefit of a prospective customer of such person, if orders by such customer to such person to enable such customer to fill orders resulting from such solicitation are orders described in paragraph (1).”

Some tax variations:

Delaware: no state corporate income tax on out of state transactions. (See generally DEL shelter: http://www.nytimes.com/2012/07/01/business/how-delaware-thrives-as-a-corporate-tax-haven.html?pagewanted=all&_r=0, accessed Jan 14, 2013; and see also Del tax center: http://www.delaware.gov/topics/TaxCenter.)

NV, SD, WY: no state corporate income tax

States with no individual income tax:• • Alaska• Florida• Nevada• South Dakota• Texas• Washington• Wyoming

http://www.delaware.gov/topics/TaxCenter

http://www.nytimes.com/2012/07/01/business/how-delaware-thrives-as-a-corporate-tax-haven.html?pagewanted=all&_r=0

http://www.nytimes.com/2012/07/01/business/how-delaware-thrives-as-a-corporate-tax-haven.html?pagewanted=all&_r=0

Two states have a limited income tax on individuals. These states tax only dividend and interest income:

• Tennessee• New Hampshire

States with no sales tax: (Good for sales operations sites: check before using the jurisdiction to be sure the state’s laws allow licensing charges to be remitted to a no income tax state for HQ entity. Also note difference between “unitary” and non-unitary businesses for tax allocation, see below.)

AKDELNHMTOR

Unitary businesses may not be able to avoid tax on their separate business units. For purposes of state corporate taxation, the determination of whether income is classified as “business” or “nonbusiness” can have significant tax implications. The U.S. Supreme Court recently addressed this issue in Meadwestvaco Corporation, Successor in interest to Mead Corporation v. Illinois Department of Revenue, 553 U.S. 16 ( 2008). In this case, the taxpayer, an Ohio corporation with its headquarters in Ohio, had sold one of its business divisions (the Division) with headquarters located in Illinois. Although the Division’s regular business activities were subject to Illinois income tax, the taxpayer took the position that the gain on the Division’s sale constituted “nonbusiness” income that was not subject to Illinois tax. As nonbusiness income, the taxpayer allocated the gain to Ohio (the taxpayer’s state of domicile) for state income tax purposes.

In Meadwestvaco, the Court was asked to address whether Illinois constitutionally had the right to tax as business income a significant capital gain realized by an out-of-state corporation on the sale of one of its business divisions based on the state’s apportionment factors. If the gain were determined to be nonbusiness income, the gain would not be subject to tax in Illinois, and the taxpayer would have a right to a refund of Illinois income tax and penalties totaling approximately $4 million.In its decision, which did not resolve the issue, the Supreme Court concluded that the state appellate court had failed to address the “key” factor needed for resolution - whether the Division and the taxpayer were a “unitary business.”Although the Illinois trial court determined that the Division was not a unitary part of the taxpayer’s business, it concluded that the state could tax the taxpayer’s capital gain on an apportioned basis. In affirming the trial court’s decision, even though the Illinois appellate court had determined that the Division served an “operational” function in the taxpayer’s business, the appellate court failed to address the issue of whether the Division and the taxpayer were a “unitary business.” The Supreme Court therefore remanded the case back to the state appellate court to consider whether the Division and the taxpayer’s business were unitary.Shaping the legal issues required to reach a conclusion, the Supreme Court’s opinion notes that a state’s power to tax out-of-state activities is derived from the application of the Commerce Clause and Due Process Clause of the U.S. Constitution. Since the Division was doing business in Illinois, the Due Process requirement had been met - there was a definite minimum connection between Illinois and the transaction it sought to tax. To meet the requirement of the Commerce

Clause, the inquiry shifted from whether the state may tax to what it may tax. The Supreme Court noted that it had developed the “unitary business principle” to answer just such a question.

Under this principle, a state need not “isolate the intrastate income-producing activities from the rest of the business” but “may tax an apportioned sum of the corporation’s multistate business if the business is unitary.” A court must determine whether the intrastate and interstate activities form part of a single unitary business. Thus, where the value of what a state wants to tax is derived from a “unitary business” operated both in and out of state, the state can tax on an apportioned basis (generally, a state’s apportionment factors include sales, property, and compensation in the state) versus an attempt by the taxing state to isolate the value attributable to the operation of the business within the state. On the other hand, if the value to be taxed by the state is derived from a “discrete business enterprise,” the state cannot tax even an apportioned share of that value. Although it may be easy to identify the principle to be applied, it has been difficult for state courts to define when a business is “unitary.” Towards this end, courts have determined that where the asset at issue served an “operational” function, such a finding was instrumental in addressing the constitutional relevant conclusion that the asset was a unitary part of the business being conducted in the taxing state rather than a discrete asset to which the taxing state had no claim.Where the asset in question is another business, the Supreme Court described the “hallmarks” of a unitary relationship as “functional integration, centralized management, and economies of scale.” In Meadwestvaco, the state trial court concluded that these “hallmarks” were lacking and concluded that the Division was not part of the taxpayer’s business. The salient facts in the case included the following:

• although subject to the taxpayer’s oversight, the taxpayer did not manage the day-to-day affairs of the Division• the headquarters of the taxpayer and the Division were located in different states, with the taxpayer and the Division having their own management teams• the two businesses maintained separate manufacturing, sales, and distribution facilities, as well as separate accounting, legal, human resources, credit and collections, purchasing, and marketing departments• the taxpayer’s involvement, generally, related to approving the Division’s business plan and any significant corporate transactions (such as capital expenditures, financings, mergers and acquisitions, or joint ventures)• the taxpayer and the Division were not required to purchase from each other and, if they did, there were no discounts, etc.

III. ORGANIZATIONAL FILINGS AND FORMS NEEDED

A. [3.128] LLC Organization and Tax Registration

Many clients do not want elaborate advice on tax, liability, or other alternatives to limited liability companies. The practitioner should provide at least minimal information on such alternatives, but this can be done by, e.g., giving them the Department of Commerce and Economic Opportunity’s STARTING YOUR BUSINESS IN ILLINOIS, www.commerce.state.il.us/dceo/bureaus/entrepreneurship+and+small+business/publications. This section outlines the forms and steps needed for basic LLC formation and tax registration. Be careful when filling

out forms. If you indicate, for instance, that the company being formed sells tangible goods and services, your client will need to file retailers’ occupation tax forms regularly, not just reports of income tax due. See generally Secretary of State, A Guide for Forming Domestic Limited Liability Companies, www.cyberdriveillinois.com/publications/pdf_publications/c334.pdf.

Check for name availability. Pick a name that will not be confusingly similar to any other entity or business now in operation. Do a Corporation/LLC Name Availability search online at www.cyberdriveillinois.com/departments/business_services/corp.html. Do an LP/LLLP/LLP Name Availability search online at www.cyberdriveillinois.com/departments/business_services/lpsearch.html. Do a trademark search by, e.g., searching the name with an Internet search engine and checking state and federal trademark registries at www.uspto.gov/trademarks/process/search and www.cyberdriveillinois.com/departments/business_services/trademark.html. NOTE: If the client desires trademark filing, once the entity is filed, examine the Trademark Registration and Protection Act, 765 ILCS 1036/1, et seq., and Registration and Protection of Trademarks and Servicemarks, www.cyberdriveillinois.com/publications/pdf_publications/c249.pdf. Regarding federal trademark filing, see also www.uspto.gov/trademarks/basics/index.jsp. Do an Internet Corporation for Assigned Names and Numbers (ICANN) website name availability search (i.e., a WHOIS search) at any registrar site, such as www.allwhois.com, www.register.com, www.godaddy.com, www.networksolutions.com. Note that the registration service may be a free add-on to Internet hosting service, which should be researched on price, anonymity of owner, merchant account linkage, site software, etc.

File LLC Form 5.5, Articles of Organization, www.cyberdriveillinois.com/departments/business_services/publications_and_forms/llc.html. See §§3.45 – 3.57 below for comments on filling in the form. For the price of an expedited service fee, you can use the online filing option for quicker filing and results. See www.ilsos.gov/llcarticles/frontinstructions.html. Pay careful attention to restrictions on use of words like “bank” or “banking,” Olympics references, corporate fiduciary functions limits (unless registered as same), and other common reasons for “go-backs” (i.e., rejections of your filing by the Department of Business Services, which cost time and embarrassment.)

Apply for an Employer Identification Number. Download IRS Form SS-4 from www.irs.gov/pub/irs-pdf/fss4.pdf. This should be filled in online for fastest results. There is no charge for either hard-copy or online FEIN request. See www.irs.gov/businesses/small/article/0,,id=102767,00.html.

Register with the Illinois Department of Employment Security. Download Form UI-1 from www.ides.state.il.us/pdf/forms/ui1.pdf to see the questions. Register (and later pay, if you have employees) online at Illinois TaxNet, https://taxnet.ides.state.il.us.

Register for other Illinois taxes. Find the Illinois Department of Revenue (IDOR) Form REG-1 at www.revenue.state.il.us/taxforms/reg/reg-1.pdf. This and the associated schedules (also available for download at the IDOR site) give the questions you will need to answer. For immediate registration, file online at http://tax.illinois.gov/businesses/register.htm.

Register for professional or other industry-specific permissions to operate, if applicable. For instance, lawyers must register with the Attorney Registration and Disciplinary Commission to practice law. If the business being formed needs state permissions to operate (e.g., new source

registration from the state Environmental Protection Agency for potential sources of air pollution), apply for these before beginning operations. Similarly, comply with nonprofit charitable registration or other special registration statutes.

Register for local taxes, if any, and check zoning for location-relevant permission to operate, as well as any “general business” or other entity registration requirements that apply.

Draft and execute an operating agreement for the new LLC. See §3.61 below for a sample form for a single-member LLC. The operating agreement is a record of the organization and should be kept with ownership records, records of agreements, and other books and records that may be needed to resolve IRS or corporate controversies. The registered agent or primary manager may be the records custodian.

Create a legal and tax reports due calendar for the new entity. This should include dates for annual and periodic federal and state income tax, retailers’ occupation tax/use tax, local and special taxes (if any), unemployment insurance taxes (if any), Social Security/Medicare taxes (if any), annual entity reports to the Department of Business Services due dates, and any other dates relevant to professional registration or internal organization and local ordinance compliance needed.

Remind your client by e-mail of tax and other due dates, vendor contracts, employee contracts and policies, financing assistance, and other legal services that the new business entity may need. Some may be helpful or necessary at startup.

B. [3.139] Regulated Entity Compliance Certificates

Almost any form of business may require federal, state, or local licensing, with consequent periodic reporting, in addition to the filing of assumed business name or entity registration forms. As in Chicago’s instance, the licensing may be combined with particular home-rule tax incidence and reporting or may require initial or periodic examination, continuing education, re-qualification, or annual or other periodic license payments.

The full scope of line of business regulation for, e.g., securities, insurance, public utilities, banking, airlines, or railroads, and the full requirements of licensing statutes for professions like law, accounting, architecture, or plumbing are beyond the scope of this chapter. Readers should be familiar with whatever is required for the client seeking their advice and should help assure compliance with local, state, and federal regulations on registration, qualification to practice, periodic reports, and other compliance elements. These, and LLC initial registration and periodic regulatory certification, can be included in a company’s International Organization for Standardization (ISO) 14000 environmental management standards certification and in the more general ISO 9000 management standards, both of which have commercial and legal significance. Major entities may not deal with suppliers that cannot document compliance. See www.iso.org/iso/iso_catalogue.htm.

805 ILCS 180/1-25 adds industry-specific requirements for use of the LLC form for the following professions:

Insurance. Groups of underwriters, incorporated and unincorporated, must have a finding from the Director of Insurance that the group meets the requirements of §86(3) of the Illinois Insurance Code, 215 ILCS 5/86(3), and the LLC, if insolvent, must be subject to liquidation by the Director of Insurance under Article XIII of the Illinois Insurance Code, 215 ILCS 5/187, et seq.

Dental practice. Members and managers must be licensed as dentists under the Illinois Dental Practice Act, 225 ILCS 25/1, et seq.

Medical practice. All the managers, if any, must be licensed to practice medicine under the Medical Practice Act of 1987, 805 ILCS 60/1, et seq., and each member must be

(A) licensed to practice medicine under the Medical Practice Act of 1987; or

(B) a registered medical corporation or corporations organized pursuant to the Medical Corporation Act [805 ILCS 15/1, et seq.]; or

(C) a professional corporation organized pursuant to the Professional Service Corporation Act [805 ILCS 10/1, et seq.] of physicians licensed to practice under the Medical Practice Act of 1987; or

(D) a limited liability company that satisfies the requirements of subparagraph (A), (B), or (C). 805 ILCS 180/1-25(4).

Note that similar restrictions on ownership may exist in licensing statutes, even though these are not explicitly cross-referenced in the Limited Liability Company Act.

Architectural design professionals. Architectural design professionals must be licensed, and advertising by firms must carry the firm’s registration license. 225 ILCS 305/23.5. Such firms may not be registered unless

(1) two-thirds of the board of directors, in the case of a corporation, or two-thirds of the general partners, in the case of a partnership, or two-thirds of the members, in the case of a limited liability company, are licensed under the laws of any State to practice architecture, professional engineering, land surveying, or structural engineering; and

(2) (2) a managing agent is (A) a director in the case of a corporation, a general partner in the case of a partnership, or a member in the case of a limited liability company, and (B) holds a license under this Act. 225 ILCS 305/21(b).

The LLC Act, 805 ILCS 180/5-5 ( c ) allows organization for the purpose of accepting and executing trusts, but requires the filing of a certificate a statement executed by the Commissioner of the Office of Banks and Real Estate that the organizers of the limited liability company have made arrangements with the Commissioner of the Office of Banks and Real Estate to comply with the Corporate Fiduciary Act. Similarly, 805 ILCS 180/5-5(d) requires that Articles which are filed in order that the entity formed engage in banking be further filed with the Commissioner

of the Office of Banks and Real Estate, or with the appropriate federal banking authorities.

By contrast, many licensing requirements in other statutes and state rules apply to mandate operator qualifications but do not restrict ownership in the operating entity. For example, attorneys-at-law are regulated by the Supreme Court Rules on Admission and Discipline of Attorneys, S.Ct. Rule 701, et seq. S.Ct. Rules 721 and 722 specify the requirements for attorney practice in limited liability organizations. Rule 721(c) prohibits the practice of law and the opening of an establishment for such practice in Illinois by a corporation, association, limited liability company, or registered limited liability partnership unless such organization has a certificate of registration issued by the Illinois Supreme Court. Note that the Attorney Act, 705 ILCS 205/0.01, et seq., prohibits unlicensed practice and provides for contempt of court sanctions, both equitable and punitive, for soliciting legal business or for practicing when unlicensed.

Rule 721 requires that

each natural person shall be licensed to practice law who is (A) a shareholder, officer, or director of the corporation (except the secretary of the corporation), member of the association, member (or manager, if any) of the limited liability company, or partner of the registered limited liability partnership, (B) a shareholder, officer, or director of a corporation (except the secretary of the corporation), member of an association, member (or manager, if any) of a limited liability company, or partner of a registered limited liability partnership that itself is a shareholder of a corporation, member of an association, member (or manager, if any) of a limited liability company, or partner of a registered limited liability partnership engaged in the practice of law, or (C) engaged in the practice of law and an employee of any such corporation, association, limited liability company, or registered limited liability partnership

and that the entities not violate any other rules attorneys must comply with in practicing before Illinois courts. Note that Illinois Rule of Professional Conduct 5.4 restricts division of fees and other professional associations with nonlawyers. The net effect is that, for instance, nonlawyers could inherit a lawyer’s interest, but they could not practice in LLC form, but they would be able to sell such interest to another practicing lawyer. Creditors, similarly, could receive a charging interest on a lawyer’s distributive interests under the LLCA but could not control or otherwise manage in any way the active practice of law, just as those with charging orders in other circumstances lack management rights. See 805 ILCS 180/30-20.

S.Ct. Rule 722 subjects owners of law practices operating as LLCs or other limited liability entities to liability for claims up to the amount of the deductible of their malpractice policies or for the amount of the minimum for such policies (or for proof of financial responsibility for such amounts, if no policy is in hand). The required minimum coverage or financial responsibility proof is “a minimum amount of insurance of $100,000 per claim and $250,000 annual aggregate, times the number of lawyers in the firm at the beginning of the annual policy period, provided that the firm’s insurance need not exceed $5 million per claim and $10 million annual aggregate.” S.Ct. Rule 722(b)(1).

An application for certificate of registration is required before the Supreme Court will issue a firm registration under S.Ct. Rule 721. There is a link to the registration information on the Attorney Registration and Disciplinary Commission’s (ARDC) website at www.iardc.org/registration/reg_faqs.html and www.iardc.org/registration/profsvcentity.html. The Supreme Court website has a link to the form at www.state.il.us/court/supremecourt/prof_serv/default.asp. There is a filing fee of $50.

Each attorney and law firm is required to report trust account and malpractice insurance status under S.Ct. Rules 756 and 722. The ARDC has information on these requirements at www.iardc.org/registration/unifiedreport_instruct.html.

The relevant statute governing landfills requires a permitted person, but not that such person be the owner. This means that ownership and management are not restricted. The permit signer will presumably be required to be the licensed professional. 225 ILCS 230/1004.

805 ILCS 180/1-28 requires a Department of Financial and Professional Regulation certificate of registration for any LLC that “intends to provide, or does provide, professional services that require the individuals engaged in the profession to be licensed by the Department of Financial and Professional Regulation.” Initial certificates are $50, with $40 to be paid to that Department for annual renewal certificates.Certficate fees should be determined by contacting the Department of Financial and Professional Regulation, as these vary by profession. Contact information for the Department is as follows:

320 W. WashingtonSpringfield, IL 62786Phone: 217-785-0800TDD: 217-524-6735Fax: 217-782-7645

100 W. Randolph, 9th Floor Chicago, IL 60601 Phone: 312-814-4500TDD: 312-814-2603Fax: 312-814-3145

The Department’s website, which lists the professions and occupations it regulates, is www.idfpr.com.

C. Not-for-Profit Organizations

1. [3.140] Charitable Trusts Registration and Reporting

Charities and nonprofits, religious and nonreligious, may need to register with the Charitable Trusts Bureau of the Office of the Attorney General or file forms indicating that the organization is exempt from registration and reporting. Such entities could be formed under the Limited Liability Company Act, the Business Corporation Act of 1983 (BCA), 805 ILCS 5/1.01, et seq., the General Not For Profit Corporation Act of 1986, 805 ILCS 105/101.01, et seq., the Religious

Corporation Act, 805 ILCS 110/0.01, et seq., or other special legislative acts. The Charitable Trusts Bureau website is www.illinoisattorneygeneral.gov/charities/index.html.

Not-for-profit organizations may be subject to the Charitable Trust Act, 760 ILCS 55/1, et seq., which requires registration with and financial reports to the Attorney General. See 760 ILCS 55/5, 55/7. Religious organizations may be exempt from reporting but may still be required to apply for exemption. 760 ILCS 55/4(a). The registration forms are Form CO-1, Charitable Organization — Registration Statement; Form CO-2, Charitable Organization — Financial Information Form; and Form CO-3, Charitable Organization — Religious Organization Exemption Form, which are available on the Attorney General’s website at www.illinoisattorneygeneral.gov/charities/index.html.

Exemptions from sales taxation under the Retailers’ Occupation Tax Act, 35 ILCS 120/1, et seq., and the Use Tax Act, 35 ILCS 105/1, et seq., may also be available, as well as exemptions from local property taxation under the Property Tax Code, 35 ILCS 200/1-1, et seq. The sales tax exemption requires filing with the Illinois Department of Revenue of the Code §501(c)(3) recognition letter that would be the result of a successful application for recognition of exemption to the IRS. The property tax exemption filing, which is made to the local property tax appeals entity relevant to the county where the property in question is located, also requires proof of exclusively charitable or religious use for the property in question. 35 ILCS 200/15-10. See also 35 ILCS 200/15-40, 200/15-65.

Religious organizations may be exempt from annual reporting under the Charitable Trusts Act but are still required to file the proof that they are exempt with the Charitable Trusts Bureau.

2. [3.151] Religious Organizations

For religious organizations, most states have a form of organizational registration that avoids any determination of organizational form, rights to organizational property, methods for resolving disputes, or other state interference with the internal governance of the religious body. In Illinois, this form is provided by the Religious Corporation Act. Churches, mosques, and other religious organizations also can and do use the General Not For Profit Corporation Act of 1986. The “any lawful purpose or business” language of §1-25 of the Limited Liability Company Act permits not-for-profit organization under the LLCA as well. 805 ILCS 180/1-25.

D. [3.162] Tax Exemption

Not-for-profit organizations may potentially be exempt from federal and state taxation, but they lack (by definition and by tax exemption requirements) the ability to distribute profits to managers or to contributors except as fair market value salaries.

1. [3.173] Federal Income Tax Exemption

Income taxation of entities may be excluded for qualified not-for-profit organizations. See generally Code §§509(a)(1) and 170(b)(1)(A)(i) – 170(b)(1)(A)(vi) for publicly supported charities exempt from taxation as private foundations. In general, exemption is governed by Code §501(a). Also, see generally IRS Publication 557, Tax-Exempt Status for Your Organization; IRS Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal

Revenue Code. IRS forms and publications are available at www.irs.gov/formspubs. Counsel should cooperate with accounting professionals to prepare these materials, as multiple years of budget history or projections will be needed.

Annual filings of IRS Form 990-T, Exempt Organization Business Income Tax Return (and proxy tax under section 6033(e)), and Form IL-990-T, Exempt Organization Income and Replacement Tax Return, as well as unrelated business income tax returns and sales and unemployment tax filings may be needed.

Exempt organizations pay income tax at the maximum rate at the entity level if the income is unrelated to their exempt purposes and they otherwise do not pay income taxes. Salaries are the only permitted form of distribution, apart from repayment of debt or payment of ordinary and necessary business expenses. These distributions are subject to individual income taxation if they are made to individuals. See generally IRS Publication 557, Tax-Exempt Status for Your Organization.

CAVEAT: P.A. 96-126 (eff. Jan. 1, 2010) added the definition for ‘“L3C” or “low-profit limited liability company” and other provisions concerning such organizations to 805 ILCS 180/1-5. This designation is completely irrelevant for use of the LLC as a nonprofit, as LLCs may be organized for any lawful purpose. Use of a low-profit LLC will make federal tax exemption impossible, as such organizations (by definition) have profits, and federal exemption requires that no portion of the income of any entity applying for exemption accrue to any individual or organization, except for fair value of items provided or services rendered. See IRS Publication 557, especially the provisions suggested for Articles of Incorporation or of Organization. The low-profit LLC is a trap for the unwary, and the legislation should be repealed.

The correct way to have some income for investors and a nonprofit function that is exempt is for the nonprofit to form a for-profit subsidiary, not a single, combined, nonexempt low-profit LLC.

a. [3.184] Religious Organization Exemptions

Religious organizations may be exempt from both initial qualification rulings and annual reporting. Initial filing for recognition of the exemption is recommended, to provide donors assurance of deductibility of contributions.

Federal and state tax exemption for religious organizations can present complex issues of initial and continuing qualification for exemption. Private “inurement” (i.e., receipt of funds for something other than the market value of goods or services provided to the organization) of organizational profits or exclusive benefits to insiders can endanger the exemption. So too can lobbying or participation in political campaigns. The income of these organizations and their affiliates must be exclusively obtained in the course of exempt activity, or it is subject to “unrelated business income” tax. Such taxable income includes things like revenues from advertising in religious publications, gaming (except bingo), sale of merchandise or publications, or rental income. Salaries and benefits for members of the clergy have potential exemptions from Social Security and Medicare taxation. See generally IRS Publication 1828, Tax Guide for Churches and Religious Organizations; IRS Publication 598, Tax on Unrelated Business Income of Exempt Organizations; IRS Form 1023, Application for Recognition of Exemption Under

Section 501(c)(3) of the Internal Revenue Code; IRS Form 990, Return of Organization Exempt From Income Tax; and IRS Form 990-T, Exempt Organization Business Income Tax Return (and proxy tax under section 6033(e)), as well as the accompanying instructions to these forms, all of which are available at www.irs.gov/formspubs.

Religious organizations usually have extensive internal provisions for governance, either hierarchical or nonhierarchical. The Catholic Church clearly represents a hierarchical organization, with its corporations organized at the diocesan level, and the head of each ( i.e., bishops and archbishops) is replaceable and responsible to the Pope. Likewise, the Presbyterian Church uses hierarchical governance, with congregational elders for individual churches, groups of churches organized in presbyteries, and, at the national level, organization in general assemblies. Nonhierarchical governance typifies independent congregations of Baptists or churches not affiliated with any denomination. Many denominations have group exemption letters that qualify each of the local congregations that form under the rules of the religious group for income tax exemption without a new application to the IRS for recognition of such exemption, thus avoiding the six or more months’ wait for a decision. See IRS Publication 1828.

Local trustees and separate property ownership (or management organizations or corporations) are also common, with or without specific reference in a suborganization’s documentation to the church polity’s general standards for congregational governance and leadership succession. As might be expected, property and doctrinal fights in these organizations can be messy. First Amendment principles of noninterference by secular courts in religious affairs can be at odds with charitable purposes doctrines and the property control expectations of various factions. For-profit or not-for-profit entities are often used in religious contexts with separation of functions planned in advance to avoid confusion in the event of tax, employment law, or other disputes. Limited liability companies are one way to organize taxable properties and other local or national support organizations for these religious groups. Proof of “integrated auxiliary” status or independent basis for proof of exclusively religious, charitable, educational, cultural, or scientific activity sufficient to qualify for exemption from income taxation under Code §501(c)(3) may be needed from a religious organization client.

Note that under the Unemployment Insurance Act, 820 ILCS 405/100, et seq., not-for-profit organizations may be exempt from unemployment insurance tax for certain religious employees. 820 ILCS 405/211.3. See Illinois Department of Employment Security, Guide to the Illinois Unemployment Insurance Act (Oct. 2009), www.ides.state.il.us/publications. See also the regulations of the Illinois Department of Employment Security, 56 Ill.Admin. Code pts. 2712 – 2960.

b. [3.195] Political Organization Exemptions

Political committees at the local, state, and federal levels are subject to ethics requirements for persons that lobby for or with them, disclosure requirements to election commissions, and to tax reporting and registration. They may be exempt from federal income taxation.

In political campaigns, entities based on candidate, local, state, or national party, interest group, or coalition generate, administer, and make ethics, tax, and election regulation reports. Political committees can operate free of tax, but they must expend their funds within state or federal election law limits on pain of taxation at the highest corporate rate or loss of public

funding, along with civil and criminal fines. For information on filing and exemption requirements for various types of political organizations, including federal committees (e.g., the “independent” political committees authorized for exemption under Code §527), see www.irs.gov/charities/political/index.html.

2. [3.2016] Sales Tax Exemption

Once an organization has an income tax letter, the entity can apply for exemptions from the Illinois retailers’ occupation tax and the Illinois use tax. An exemption number will be required in future purchases and sales. Illinois Department of Revenue Publication 104, www.revenue.state.il.us/publications/pubs/pub-104.pdf, explains such exemption in general. Publication 104 references 86 Ill.Admin. Code §§130.2005 and 130.2007 and Brochure PIO-37, http://tax.illinois.gov/publications/pios/pio37.htm.

3. [3.2117] Property Tax Exemption

The Property Tax Code (part of the Revenue Act, which also governs sales and income taxes) allows exemption from property taxes for exclusively charitable use. Proof is required for each parcel, and application to county boards of review (in Cook County, the Appeals Board) is required. Their decisions are then reviewed by the Illinois Department of Revenue. See Brochure PIO-37, http://tax.illinois.gov/publications/pios/pio37.htm. IDOR decisions on specific issues are available at www.revenue.state.il.us/legalinformation/hearings/pt/index.htm.

Property tax exemption decisions are frequently appealed to the courts, and court rulings on such decisions have changed considerably over the years. For example, the Provena Covenant Hospital in Urbana lost an appeal to the Supreme Court because lab and physician office space for an entity with less than charitable billing practices did not qualify for the “exclusive” charitable use requirement of the Code. Provena Covenant Medical Center v. Department of Revenue, 236 Ill.2d 368, 925 N.E.2d 1131, 339 Ill.Dec. 10 (2010).

E. [3.2218] Local Registration and Permits

Local business registration may be required for all, some, or no types of business depending on where the business is located in Illinois. Organizations that operate under their limited liability company name are not subject to the Assumed Business Name Act, 805 ILCS 405/0.01, et seq., which otherwise requires county-level registration. The most comprehensive regulation and registration schemes come, as might be expected, in the largest communities. Some examples:

Chicago regulates everything imaginable and may impose a tax associated with registration or with incidents of business operation. The Department of Revenue’s Licenses, Permits, and Taxes website can be accessed at www.cityofchicago.org/city/en.html.

The forms, permits, and licenses for the city of Naperville are available on the city’s website at www.naperville.il.us/community_relations_forms_permits_licenses.aspx. Information about the food and beverage tax, the real estate transfer tax, and utility payment is found at www.naperville.il.us/index_template.aspx?id=205.

Springfield business licensing forms are available at www.springfield.il.us/license/default.htm. The treasurer’s report for the most recent year available, 2010, listed pari-mutuel betting, foreign fire insurance, city hotel/motel, state auto rental, charitable games tax and license, and telecommunications tax revenue under “miscellaneous taxes.” www.springfield.il.us/treasure/monthlyreports/fy2010_filed_annual_report.pdf.

IV. FOR-PROFIT ENTITY TAX INCIDENCE

A. [3.2319] Tax Planning

Limited liability companies can function as almost any type of taxable or tax-exempt organization. The Limited Liability Company Act allows their organization for “any lawful purpose.” 805 ILCS 180/1-25. The restrictions on organization for insurance company, dentistry, and medical practice in §1-25 relate to professional qualification, not to taxability. Note that the default tax status for LLCs will be that of a partnership for federal and state income and personal property replacement tax purposes.

To summarize business taxation in general, the taxes that organizations, their managers, and their investors pay may include federal or state taxes levied at the organizational level, pass-through taxes on individual income or proportional shares of income and liabilities (for organizations treated as partnerships), gross revenue and other sales taxes like those under the Retailers’ Occupation Tax Act, taxes on capital like franchise taxes under the Business Corporation Act of 1983, and a variety of local and regional levies on real property, lease revenues, or employment, like taxes under the Property Tax Code, the Chicago Personal Property Lease Transaction Tax Ordinance, Chicago Municipal Code §3-32-010, et seq., and the Chicago Employers’ Expense Tax Ordinance, Chicago Municipal Code §3-20-010, et seq. The attorney advising a new business is usually asked to minimize the taxes payable by the new entity. This job is too important to be left solely to the accountants.

B. [3.240] Federal and State Income Tax

Most businesses are subject to income tax levied only at the individual level, with liability for tax on profits regardless of whether they are distributed to owners. See generally William A. Price, Ch. 2, LIMITED LIABILITY ORGANIZATIONS (2001); Mark A. Sargent and Walter D. Schwidetzky, LIMITED LIABILITY COMPANY HANDBOOK: LAW, SAMPLE DOCUMENTS, FORMS, p. 3-2 (1997 – 1998). The partnership, which has all income and expenses attributed to its members, is the default form of business tax incidence for jointly owned organizations operated for profit. The Treasury Regulations specify the default tax status of business entities and how and when organizations can elect to be taxed as associations subject to corporation income tax. Treas.Reg. §301.7701-3. Single-owner entities will be disregarded (i.e., treated in the same manner as a sole proprietorship, branch, or division of the owner) unless they elect corporation status under Treas.Reg. §301.7701-3.

Corporate income is subject to taxation at the entity level and again on distribution. Capital contributions may be subject to tax on any gain realized on distribution, together with excess accumulations of tax if amounts held at the entity level exceed reasonable business purposes. Ordinary and necessary business expenses provide a deduction from income. See, e.g., Code

§§311(b), 336. For not-for-profit organizations that fail to qualify for exemption, see IRS Publication 557, Tax-Exempt Status for Your Organization. Treas.Reg. §301.7701-2(b) makes the following organization types subject to corporation treatment by definition:

(1) A business entity organized under a Federal or State statute, or under a statute of a federally recognized Indian tribe, if the statute describes or refers to the entity as incorporated or as a corporation, body corporate, or body politic;

(2) An association (as determined under §301.7701-3);

(3) A business entity organized under a State statute, if the statute describes or refers to the entity as a joint-stock company or joint-stock association;

(4) An insurance company;

(5) A State-chartered business entity conducting banking activities, if any of its deposits are insured under the Federal Deposit Insurance Act, as amended, 12 U.S.C. 1811 et seq., or a similar federal statute;

(6) A business entity wholly owned by a State or any political subdivision thereof, or a business entity wholly owned by a foreign government or any other entity described in §1.892-2T;(7) A business entity that is taxable as a corporation under a provision of the Internal Revenue Code other than section 7701(a)(3); and

(8) Certain foreign entities.

Publicly traded organizations will be taxed as business associations, even without an election of this status, unless special exemptions (such as those for real estate investment trusts) apply. See generally Joel Shapiro, Final Regulations on Publicly Traded Partnerships Reflect Practitioners’ Comments, 14 J. Partnership Tax’n 144 (1998).

Note that the above may not apply to S corporations. The American Jobs Creation Act of 2004, Pub.L. No. 108-357, 118 Stat. 1418, increased the number of shareholders allowable in such entities to 100 and contains no exception for publicly traded companies. 26 U.S.C. §1361. The tests for “securities” that may require public registration for their offerings may be triggered by significantly lower numbers. Section 4(2) of the federal Securities Act of 1933, 15 U.S.C. §77a, et seq., as amended (15 U.S.C. §77d(2)), and the Security and Exchange Commission’s Regulation D that resulted from it (17 C.F.R. §§230.501 – 230.508), provide a limited exception to public offering requirements and are the usual exceptions relied on by promoters of “private” offerings. For instance, the Regulation D exemption references 35 investors. Any number of publicly traded entities that are otherwise qualified under Subchapter S could, presumably, form a commonly owned pass-through entity and thus have any number of public investors without paying organization-level tax, as long as they comply with SEC and state securities laws.

Even if no entity is organized under business organization statutes, there may be joint tax liability. If individuals own property jointly, then they will be responsible for their pro rata

ownership shares of costs and of income for tax purposes. See Rev.Rul. 75-374, 1975-2 Cum.Bull. 261.

Illinois income tax law follows the federal tax treatment of not-for-profit organizations and of partnership taxation or business association elections.

C. [3.251] Filings Needed To Obtain Specific Federal Tax Treatments

Sections 3.242 – 3.264 below summarize the possible tax status and regular tax filings needed for various limited liability company taxable and nontaxable types of status.

D. Status Available Without Election Filings

1. [3.262] Disregarded Entity

Treas.Reg. §§301.7701-3(b)(3)(i) and 301.7701-3(f)(2) specify that for organizations having only one owner in existence prior to January 1, 1997, and having elected to be taxed as partnerships, the organization will be disregarded as an entity. This means that no organization-level tax applies. Owners can simply file an annual Schedule C and pay taxes on organizational income as they would for any other business conducted under their social security numbers. A social security number can be used for a business if only the owner is involved in its operation. The business should obtain a separate employer identification number, using IRS Form SS-4, Application for Employer Identification Number, if employees are hired.

A single-member limited liability company is disregarded (i.e., treated in the same manner as a sole proprietorship, branch, or division of the owner), and its tax is the same as for an individual-owner sole proprietorship. The LLC must file an annual IRS Form 1040, U.S. Individual Income Tax Return, and IL-1040, Illinois Individual Income Tax Return, and make quarterly estimated tax filings. The LLC may have sales tax responsibility and may incur unemployment insurance tax if the owner pays himself or herself a salary instead of dividends.

Single-member are LLCs disregarded for state income tax purposes. Ill.Rev.Pvt.Ltr.Rul. IT-02-0005-PLR (Dec. 18, 2002).

2. [3.273] LLC Taxed as a Partnership

Treas.Reg. §301.7701-3(a) specifies that a domestic business entity is eligible to make a status election if it is not otherwise required to be taxed as a corporation. If it does not make an election, it will be taxed as a partnership if it has two or more owners. Treas.Reg. §301.7701-3(b)(1)(i). This means that the attribution to members of all expenses and income that are characteristic of a partnership is the default form of business organization taxation that will apply unless an organization is one of the types listed in Treas.Reg. §301.7701-2(b), i.e., a corporation by definition.

Illinois imposes a 1.5-percent tax on net income as a corporate “personal property tax replacement tax” on entities taxed as partnerships, on trusts, and on corporations that have elected pass-through tax treatment under Subchapter S of the Internal Revenue Code. 35 ILCS 5/201(d). This is in addition to any individual income taxes payable based on capital gains distributions to

partners or to the taxes that may result from the attribution of partnership income and loss to individual partners, regardless of whether income is distributed (“pass-through” tax treatment).

A partnership LLC is taxed like a partnership for federal and state tax purposes. The LLC files an annual partnership return, with quarterly estimated returns if needed, and passes through information to members, which they then use to report and pay income taxes due on their annual Form 1040s. Members may have unemployment and self-employment tax incidence or out-of-state withholding, depending on the personal service nature of the business. Sales and unemployment tax payments also may be due.

For more partnership tax treatment information, counsel should consult the “check-the-box” regulations, Treas.Reg. §§301.7701-1 through 301.7701-4. Further partnership tax information is available on the IRS’ website at www.irs.gov/businesses/partnerships/index.html. See also IRS Publication 1518, IRS Tax Calendar For Small Businesses and Self-Employed, and IRS Publication 1066C, Virtual Small Business Tax Workshop (CD).

3. [3.284] Limited Partnership LLC

A limited partnership-type limited liability company is member-managed with passive investors or other beneficiary members and pays partnership tax, but with an additional wrinkle. If passive members are family members receiving membership interests as part of an estate valuation freeze or gifting plan, then annual gift limits or gift tax returns need to be considered.

None of the entities discussed in §§3.22 and 3.23 above needs to file any election of status forms.

E. [3.295] Entity Status Requiring Election or IRS Qualification Decisions

Any business corporation status will need appropriate tax filings to elect the relevant tax status. See §§3.3026 – 3.3828 below.

1. [3.3026] S Corporation Status

A limited liability company taxed as an S corporation is still a pass-through entity and may be useful to fix capital gain and loss amounts as cash contributions. S corporation election is made by filing IRS Form 2553, Election by a Small Business Corporation (Under Section 1362 of the Internal Revenue Code). Note the need for a corporate resolution of the board or sole shareholder or of all shareholders to support the election. This filing eliminates “hot asset” and other complex partnership tax rules. It requires an annual corporate income tax filing with information filings to members, who then pay individual income tax on their shares of organizational gains. Sales and unemployment tax filings are required as needed, as are estimated tax filings. The annual tax reporting form is Form 1120S.

2. [3.3127] C Corporation Status

Organizations that are taxed as business associations must pay federal income tax up to the maximum corporate rate at the entity level based on net income unless a Subchapter S election is in effect. Code §11(b). They must also pay a 15-percent tax on distributed dividends and a capital

gains tax upon sale of the business, and individual income taxes must be paid for distributions taken as salary (though these are deductible from the corporation’s gross income if they meet the tests for ordinary and necessary business expenses).

These organizations must also pay the Illinois corporation income tax at 4.87 percent and the corporate personal property replacement tax at 2.5 percent, with both taxes assessed on net income at the entity level. 35 ILCS 5/201(b), 5/201(d), see generally http://tax.illinois.gov/Businesses/TaxInformation/Income/corporate.htm, visited January 14, 2013.) Dividends or salaries are taxed again at the individual level unless a Subchapter S election is in effect.

A limited liability company taxed as a business association makes the LLC the equivalent of a C corporation, which is advantageous if the intent is to retain gains in the entity and to profit from reinvestment of the gains, as long as the organizational tax rate is significantly lower than the individual rate. Double taxation (corporate and individual rate) applies, so counsel should consider not paying dividends or income and realizing any profits as capital gains, which can be sheltered by charitable remainder trusts.

To elect business association treatment for an LLC or other entity otherwise routinely treated as a partnership under the “check-the-box” regulations (Treas.Reg. §§301.7701-1 through 301.7701-4), IRS Form 8832, Entity Classification Election, should be used.

The form includes a consent statement that may be signed by all members or by one member on behalf of all members. If one member signs, there should be some record in company membership meetings that all members approved this election.

You must provide owners’ names and identifying numbers (i.e., social security number for a single-member LLC or employer ID for a multiple-member LLC).

3. [3.3128] LLCs Pay No Illinois Franchise Tax

LLCs do have one big state tax advantage, if they have significant capitalization: they pay no franchise tax. An S corporation or a C corporation would pay Illinois franchise taxes to the extent that earnings are retained as organizational capital. 805 ILCS 5/15.40. Organizations incorporated in other states would also pay their home-state franchise tax or organizational fees, if any. The Illinois franchise tax rate is one tenth of one percent of the “paid-in capital,” which is the sum of stated capital plus paid-in surplus of income over expenses for the organization. 805 ILCS 5/15.45. After January 1, 2004, the maximum franchise tax is $2 million; the minimum is $25. Id. For a retained earnings amount of $50,000, the annual franchise tax would be $50.

V. [3.3229] SELF-EMPLOYMENT TAX

Businesses in which income is not dependent on the personal services of the business owners may be able to reduce the amount of self-employment tax otherwise due by electing Subchapter S status or by organizing as a manager-managed limited liability company with distributions to non-managing members. The former would result in taxation of distributions as organizational

http://tax.illinois.gov/Businesses/TaxInformation/Income/corporate.htm

dividends, and the latter would result in tax treatment equivalent to that for limited partnership distributions.

A. [3.330] Self-Employment Tax Rates

The self-employment tax rate is 15.3 percent, which represents both Social Security tax and Medicare tax. Code §1401. An additional Medicare tax of 0.9% is imposed on some high income individuals. (See generally http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Questions-and-Answers-for-the-Additional-Medicare-Tax, visited January 14, 2012.) The Social Security portion is capped after taxes are applied to $106,800 of income in 2010, while Medicare taxes (2.9 percent of the 15.3 percent) are not limited. Self-employment taxes are due on wages but not on corporate dividends or subchapter S non-wage distributions.

B. [3.341] Self-Employment Regulations Applicable to a Limited Liability Company or Other Organization Taxed as a Partnership

The IRS issued Prop.Treas.Reg. §1.1402(a)-2 in 1997, relative to the application of Code §1402(a)(13). It has not been incorporated into final regulations but is still useful in determining what will be regarded as taxable. The explanation of provisions in 62 Fed.Reg. 1702, 1703 (Jan. 13, 1997), which issued this proposed regulation, provides:

Generally, an individual will be treated as a limited partner under the proposed regulations unless the individual (1) has personal liability (as defined in §301.7701-3(b)(2)(ii) of the Procedure and Administration Regulations) for the debts of or claims against the partnership by reason of being a partner; (2) has authority to contract on behalf of the partnership under the statute or law pursuant to which the partnership is organized; or, (3) participates in the partnership’s trade or business for more than 500 hours during the taxable year. If, however, substantially all of the activities of a partnership involve the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, or consulting, any individual who provides services as part of that trade or business will not be considered a limited partner.

Exclusion of any of these is possible in an LLC agreement. For LLC members who are treated as limited partners, self-employment income includes only income paid to them for their own services, as opposed to passive investment income. For those treated as general partners, on the other hand, the rule is that their partnership distributions are treated as income from self-employment and therefore subject to self-employment tax.

IRS Publication 541, www.irs.gov/pub/irs-pdf/p541.pdf, describes what income is attributable to a partner and its ordinary tax treatment as follows:

A partner generally recognizes gain on a partnership distribution only to the extent any money (and marketable securities treated as money) included in the distribution exceeds the adjusted basis of the partner’s interest in the partnership. Any gain recognized is generally treated as capital gain from the sale of the partnership interest on the date of the distribution. If partnership property (other than marketable securities treated as money) is distributed to a partner, he or she

http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Questions-and-Answers-for-the-Additional-Medicare-Tax

http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Questions-and-Answers-for-the-Additional-Medicare-Tax

generally does not recognize any gain until the sale or other disposition of the property. IRS Publication 541, p. 4.

C. [3.352] Use of Loans

It is also possible to create payments not defined as self-employment income if they come as repayments of loans or other guaranteed payments. If an investor made a loan to the organization based on, for example, proceeds of individually obtained second mortgages on residential or other real estate the investor owns, the returns on this capital would not be taxed as self-employment income.

Note that use of loans could also provide income not subject to Illinois personal property replacement tax, as such income would represent a “guaranteed payment.” Legitimate and economically substantive loan transactions, and proof of loan documentation, would of course be required to survive either state or federal audits.

D. [3.36.33] Use of a C Corporation

As long as the organization and not the individual is the fee- or income-receiving organization, and the income is not derived from an owner’s personal services, a C corporation distribution of dividends does not create self-employment tax obligations. However, such income does this would subject earnings to organization level tax.

For members in LLCs taxed as corporations, dividends are not self-employment income. Code §1402(a)(2). Note, however, that earnings attributable to employment in the organization are required, so some salary will be subject to employee or self-employment income tax withholding. The measure of what should be paid as salary is what is reasonable for the organization’s business operations.

Federal tax legislation under consideration in 2010 may change the tax treatment of C and S corporations and LLC distributions. Elimination of low capital gains rates, which is scheduled for January 1, 2011, unless Congress passes changes, would make C corporation distributions and salaries worth examining as an alternative to LLC dividends. Since 2008, individuals in the two lowest tax brackets paid zero percent long-term capital gains tax while everyone else paid 15 percent. In 2011, individuals in the lowest tax bracket will pay 10 percent while the rest will pay 20 percent. Wage income tax rates will therefore need to be compared to these returning capital gains rates in the relevant tax brackets, to see which form of distribution carries less tax.

E. [3.374] Use of an S Corporation

A Subchapter S corporation election may permit distributions not subject to self-employment tax if the owner’s personal services are not the exclusive source of organizational income. Note, however, that earnings attributable to employment in the organization are required, so some salary will be subject to employee or self-employment income tax withholding.

The S corporation is expressly excluded from "personal services corporation" treatment (See Publication 542 for a cross-reference to those rules as applied to C corporations), so the rules that apply are those that determine "reasonable" compensation. What that is is generally market based.

The only guidance in the general publication section is that if "most" of an organization’s income is from personal services, then "most" of the S corporation's income should be paid as salary.

http://www.irs.gov/businesses/small/article/0,,id=203100,00.html

The Service is allowed to recharacterize income as salary or dividends on what looks to me like an "economic realities" test. Which doesn't tell us much. Here's their page referencing tax decisions. It again recognizes the propriety of having some S corporation distributions be dividends.

http://www.irs.gov/businesses/small/article/0,,id=203099,00.html

In general, such distributions (all net income above whatever minimum salary is "reasonable") would be taxable to the extent that they exceed your basis (original capital contribution, probably whatever you put in to open your business bank account, which should be enough to meet current obligations for at least a quarter or six months or a year, depending on how conservative you want to be on the "quick" ratio for determination of adequate financing. If your current bank balance plus reasonably expectable revenue is more than probable liabilities, then your entity should get limitation of liability to amounts invested in same under state law. Federal tax only cares about basis as a limit on tax on gains. No tax applies until all amounts of basis have been exhausted. your accontant can calculate this for you.

To determine "minimum reasonable" wages, national or state data from the Bureau of LaborStatistics or other generally applicable compensation surveys for similar occupationscan be consulted.

Remember that income tax is payable even if self-employment tax is not. Shareholders (or, for an LLC with a Subchapter S election, members) are liable for income tax on their shares of the corporation’s income (reduced by any taxes paid by the corporation on income). Shareholders or members must include their share of the Subchapter S organization’s income on their personal income tax return whether or not it is distributed to them. Unlike most partnership income, S corporation income is not self-employment income and is not subject to self-employment tax. See generally instructions for IRS Form 1120S. Subchapter S distributions are treated as dividends under Code §1368 unless the payment to a shareholder is a tax-free distribution that would reduce the shareholder’s basis in the organization or a distribution that exceeds the organization’s earnings and profits. S corporations are taxed on a pass-through basis on all earnings regardless of whether they are distributed to shareholders.

F. [3.385] Combined Elections

A business organization formed as a limited liability company can elect to be taxed as a business association rather than a partnership and can then elect Subchapter S status for federal tax purposes. This combination could help minimize nonpersonal services taxation for small businesses with income that results from something other than the personal services of the organization’s owner or owners. If non-managing members are willing to give up some control of the entity, organization as a member-managed LLC may suffice.

G. [3.396] Other State and Local Taxes

Separation of organizational functions into multiple entities may be appropriate as a means of reduction of other state and local taxes. If equipment lease transactions are to be a part of a business, for instance, then organization of a subsidiary that does no business in the City of Chicago may be appropriate as long as the organization is not merely a sham for tax purposes with administration and repatriation of income to the Chicago parent organization. Chicago imposes a lease transaction tax, an employer’s expense tax, and other imposts that most other Illinois municipalities do not. Similarly, an organization with multiple physical locations may want a maximum number of employees to be employed through entities not subject to the Chicago Employers’ Expense Tax.

Illinois court opinions on this topic are somewhat limited. There is 2012 authority permitting allocation of retailers occupation taxes to a DuPage County sales office, making sales not subject to ROT levied in operational locations in the County of Cook (see Hartney Fuel Oil Co. v. Hamer, 2012 IL App (3d) 110144 (Ill. App., 2012).) The Regional Transportation Authority and other governments are litigating in other jurisdictions on related issues. (See http://www.suntimes.com/17558593-761/lawsuit-sham-united-office-dodges-sales-taxes.html, visited January 14, 2013.).

VI. LIABILITY LIMITATION

A. [3.4037] Statutory Protection

Liability limitation is a significant element of the responsibilities of a limited liability company counsel and risk manager. LLCs in Illinois can efficiently limit investors’ liabilities to the capital they have committed to the enterprise:

(a) Except as otherwise provided in subsection (d) of this Section, the debts, obligations, and liabilities of a limited liability company, whether arising in contract, tort, or otherwise, are solely the debts, obligations, and liabilities of the company. A member or manager is not personally liable for a debt, obligation, or liability of the company solely by reason of being or acting as a member or manager.

* * *

(c) The failure of a limited liability company to observe the usual company formalities or requirements relating to the exercise of its company powers or management of its business is not a ground for imposing personal liability on the members or managers for liabilities of the company.

(d) All or specified members of a limited liability company are liable in their capacity as members for all or specified debts, obligations, or liabilities of the company if:

(1) a provision to that effect is contained in the articles of organization; and

http://www.suntimes.com/17558593-761/lawsuit-sham-united-office-dodges-sales-taxes.html

(2) a member so liable has consented in writing to the adoption of the provision or to be bound by the provision. 805 ILCS 180/10-10.

Previously, §10-10 was held, along with §15-3 of the Limited Liability Company Act, to create a fiduciary duty of members to each other similar to that of shareholders in a close corporation or directors and officers of a corporation to each other. In Anest v. Audino, 332 Ill.App.3d 468, 773 N.E.2d 202, 209 – 210, 265 Ill.Dec. 840 (2d Dist. 2002), the court used language likely to continue to apply under the current language of §15-3 that clearly applies some fiduciary duty standards to members of an LLC though the specific corporate analogy drawn may no longer be appropriate given the removal of reference to liabilities similar to those in business corporations in the 1997 amendment to §10-10:

Shareholders in a close corporation owe to each other fiduciary duties similar to those of partners in a partnership. Hagshenas v. Gaylord, 199 Ill.App.3d 60, 71, 145 Ill.Dec. 546, 557 N.E.2d 316 (1990) (50% shareholder owed fiduciary duties to fellow shareholders). They owe a duty of loyalty to the corporation and to other shareholders. Hagshenas, 199 Ill.App.3d at 71, 145 Ill.Dec. 546, 557 N.E.2d 316. Minority shareholders may owe a duty of loyalty to a close corporation under certain circumstances. Rexford Rand Corp. v. Ancel, 58 F.3d 1215, 1219 (7th Cir. 1995) (“Minority shareholders have an obligation as de facto partners in a joint venture not to do damage to the corporate interests”).

As set forth in the September 16 Precision Pour consent, Anest held a 121/2% membership interest in the company and was a creditor of the company. Though Anest held a minority interest, Precision Pour was a member-managed entity effective as of July 13, 1999. Thus, Anest was more than a minority shareholder; he had management responsibilities in the company. His role in the entity was, like that of his fellow members, akin to that of an officer or director in a corporation. Officers and directors in a corporation owe fiduciary duties to shareholders and to the corporation. [Kerrigan v. Unity Savings Ass’n, 58 Ill.2d 20, 317 N.E.2d 39, 43 (1974)]; see also 805 ILCS 180/10-10(b) (West 1996) (amended by Pub. Act 90-424, eff. January 1, 1998). We hold that it was against the manifest weight of the evidence for the trial court to conclude at the directed finding stage that Anest did not owe any fiduciary duty to Audino.

Note, however, that, more recently, it has been held that members may sue each other for breach of contract and other breaches of fiduciary duties, and may sue third parties who assist in such breaches. Freed v. JPMorgan Chase Bank, N.A. (N.D. Ill., 12 C 1477, 12/12/2012)

Given the potential for implied covenants not to compete and other business complications that these fiduciary duty standards may create, careful drafting of the operating agreement to define fiduciary duties (e.g., to permit investors in a real estate LLC to invest in other buildings even though they are in the same rental market as the LLC’s property) as permitted by 805 ILCS 180/15-5(b)(6) may be important.

The amendment to §10-10 was held to have eliminated member personal liability for the debts of an LLC that continued to do business after it had been dissolved. Puleo v. Topel, 368 Ill.App.3d 63, 856 N.E.2d 1152, 306 Ill.Dec. 57 (1st Dist. 2006). This section has also been held

to eliminate liability of organizers for debts and obligations they sign for an LLC yet to be formed, even if the entity is never formed. Carollo v. Irwin, 355 Ill.Dec. 49, 959 N.E.2d 77, 2011 IL App (1st) 102765 (Ill. App., 2011). What this means, for contract drafters, is that explicit provision needs to be made for entity formation and appropriate reserves before cash is allowed to be expended or agreements finalized that are supposed to include the LLC.

The same liability limit applies to managers. It was held that a bank could not hold an individual manager of an LLC liable for breach of contract under either 805 ILCS 180/35-40 or 180/10-10 because the statutes did not impose personal liability on a manager for the LLC’s debts. Wachovia Securities, LLC v. Neuhauser, 528 F.Supp.2d 834 (N.D.Ill. 2007).

Section 10-10’s protection does not help, however, if fraud or other bases for piercing the veil of a business entity apply. Veil-piercing is available with respect to members and managers of Illinois LLCs under traditional veil-piercing theories such as alter ego, fraud, or undercapitalization. Denmar Builders, Inc. v. Suhadolnik (In re Suhadolnik), No. 08-71951, 2009 WL 2591338 (Bankr. C.D.Ill. Aug. 20, 2009). While the LLCA provides specifically that the failure to observe the corporate formalities is not a ground for imposing personal liability on the members of an LLC, it does not bar the other bases for corporate veil-piercing, such as alter ego, fraud, or undercapitalization, pursuant to 805 ILCS 180/10-10. Westmeyer v. Flynn, 382 Ill.App.3d 952, 889 N.E.2d 671, 321 Ill.Dec. 406 (1st Dist. 2008).

Note that members may want to assume certain liabilities of the organization. This can increase their tax basis and thus reduce any income they might otherwise realize as a result of partnership distributions. Unless the members explicitly assume liabilities, however, indemnification agreements involving the organization do not impose liability on the individual members. Braucher v. Swagat Grp. LLC, 702 F.Supp.2d 1032 (C.D. Ill., 2010)

Section 10-10 may not provide any protection against liabilities that accrued before organization formation. In a claim by trustees of a union pension fund that the owner and his LLC were liable under 29 U.S.C. §§1132 and 1145 for neglecting an obligation to contribute to the fund, the owner could be held personally liable for acts occurring prior to the formation of the LLC; thus, the owner’s motion to dismiss pursuant to Fed.R.Civ.P. 12(b)(1) was dismissed. Dugan v. Quanstrom, 32 Employee Benefits Cas. (BNA) 1406 (N.D.Ill. 2003); but cf. Carollo v. Irwin, 355 Ill.Dec. 49, 959 N.E.2d 77, 2011 IL App (1st) 102765 (Ill. App., 2011)(held, no liability for organizer where LLC mentioned in contract, even though LLC never formed.)..

The limitation of liability to a member’s investment in the LLC makes LLCs similar to corporations and to limited partnerships in their protection against third-party claims. The forms of business and not-for-profit entities and the liability protection they provide against third-party claims are the following:

Entity Liability for Errors andOmissions of Co-Venturers

Liability for Debts andOther Claims Against

the Entity

Unincorporated Association All members, unlimited All members, unlimitedSole Proprietor N/A UnlimitedPartnership All partners, unlimited Unlimited

Limited Liability Partnership (LLP)

Partnership interest only at risk

Partnership interest only

Limited Partnership (LP) General partners: unlimited liability; limited partners: partnership interest only

General partners: unlimited liability; limited partners: partnership interest only

LLC Membership interest only Membership interest onlyCorporation Capital interest only Capital interest only

NOTE: In an LP, general partners usually organize a corporation to serve as general partner to limit liability. Also, limited partners become general partners with equivalent liability if they manage the LP.

In a manager-managed LLC, per 805 ILCS 180/15-3, a member will not owe any fiduciary duties unless he or she exercises managerial powers under the LLC operating agreement. Katris v. Carroll, 362 Ill.App.3d 1140, 842 N.E.2d 221, 299 Ill.Dec. 482 (1st Dist. 2005).

Note the following, when members exercise managerial powers:

(g) In a manager-managed company:

* * *

(3) a member is held to the standards of conduct in subsections (b), (c), (d), and (e) of this Section to the extent that the member exercises the managerial authority vested in a manager by this Act. 805 ILCS 180/15-3.

When a bankruptcy trustee alleged that members of a bankruptcy debtor LLC distributed funds to themselves from the LLC shortly before a substantial judgment was entered against the LLC for patent infringement, leaving virtually no assets for creditors, the trustee sufficiently stated a claim for breach of fiduciary duty under 805 ILCS 180/15-3. Levey v. Hamilton (In re Teknek, LLC), 354 B.R. 181 (Bankr. N.D.Ill. 2006). Similarly, allegations of fraud and self-dealing breach of fiduciary duties were allowed in Levey v. Gillman (In re Republic Windows & Doors, LLC) (Bankr. N.D. Ill., 2011)

For general articles on veil-piercing in limited liability organizations, see generally Chad Brigham, Comment, Just How Limited is the Illinois Limited Liability Company?, 26 S.Ill.U.L.J. 53 (2001); Steven G. Frost, New Revisions to the Illinois Limited Liability Company Act, 85 Ill.B.J. 592 (1997); Jeffrey K. Vandervoort, Piercing the Veil of Limited Liability Companies: The Need for a Better Standard, 3 DePaul Bus. & Com.L.J. 51 (2004). See also William A. Price, Ch. 5, LIMITED LIABILITY ORGANIZATIONS (2001, Supp. 2006).

B. [3.398] Risk Management

Liability is possible as a result of claims by third parties, claims by employees or agents, and claims by members or managers. In addition to the formation of business entities with limited liability, several methods are commonly used to reduce these exposures:

1. Careful drafting of the terms of contracts can be used. For third-party customers and for employee or agent claims, individual claims management costs can be reduced, and the amount of damages otherwise payable can be limited by inclusion in customer, employment, or agency relationship contracts of dispute arbitration, liquidated damages provisions, covenants not to compete (for employees and agents), definitions of intellectual property rights created, and limitation of warranties (for customers).

2. Organization of separate entities for different business units and for tax planning can be used. Family farms, for instance, may have a holding entity with limited management rights interests (in a limited liability company or limited partnership) handed out in planned giving programs to minimize estate, gift, and generation-skipping transfer taxes. The entity could own a hotel or other hospitality corporation or LLC, could have cattle, other stock, or equipment leasing, a supply company, and other related (but variably financed) business entities, and could have pension or other employee benefits trusts and other affiliated entities or groups as appropriate to the business and tax needs of the owners. Limitation of liability to separate business investments allows for more ease in capital formation, for private placement qualification, and for limitation of the new investment or project risk to the investors in the project and not to all the investors or beneficiaries of the parent entity.

3. Various types of insurance can be used. Professional errors and omissions insurance, fire and casualty insurance, general liability and any appropriate or required employment insurance (workers’ compensation, etc.), directors and officers insurance (pays for costs of defense even in derivative claims that otherwise might be paid by the company but assessed against the individuals if they lose), and other insurance types appropriate to particular industries (e.g., bonds for construction company bidding, fidelity bonds for corporate fiduciaries and others whose employees handle money, political risk insurance for exporters, etc.) may be as significant as business entity organization in limiting member and manager risks. Health insurance costs are often also a major concern for single-member businesses and other small groups. Techniques for insurance cost reduction include the following:

a. A small “garage startup” or other home-based business can purchase business insurance as an add-on to homeowner’s coverage.

b. A small business owner can purchase high-deductible insurance and adopt an expense reimbursement plan for medical or other costs otherwise covered by insurance. Plan reserve contributions can be deductible for the entity, and insurance is usually cheaper if deductibles are high.

c. A small business owner can purchase “umbrella” insurance, at even lower rates, for claims above a very high threshold (e.g., $1 million or more).

d. Association or other group plans (i.e., mutual insurance companies, private insurance purchasing groups, or association insurance companies) can be used as they allow reductions in rates otherwise charged to small business organizations for health and other coverage, including product liability insurance, workers’ compensation insurance, professional errors and omissions insurance, and other lines in which common risks and risk exposures can be determined. In health insurance, larger groups such as university alumni associations may avoid the adverse selection problems often present in small business group purchasing (e.g., elderly and high-cost members).

e. A small business owner can use safety certification and other risk-reduction methods (e.g., longer-term hiring at variable rates and mutually agreed hours levels throughout the year to avoid unemployment insurance tax rate increases) appropriate to the specific risks in question. Note that many insurance companies offer safety and other risk-management consultation services as a free benefit to current and potential insureds.

VII. CONTROL AND MANAGEMENT

A. [3.4039] Control

In business organizations, a variant of the philosopher’s golden rule is followed: He who has the gold makes the rules. This usually means that the bank that extends the credit essential to organizational operations, or the entrepreneur who brings in new and profitable business, or the investors who bring in the next round of capital can determine the control, management, distribution, and other internal agreements that will apply to the organization, no matter what deals have already been made between prior partners, investors, or lending organizations. That said, there are some fairly routine terms to expect:

1. For business loans, the bank will want loan conditions that reflect the type of business presented to it for loan so that proceeds are not used for different ventures or for personal expenses and sources and uses of funds match the loan application. Limits on bank risks include the right to call the loan in the event of failure to meet the payment or other conditions of the loan agreement and 90-day loan renewal cycles, together with collateralization requirements that limit lendable funds to some multiple of cash on hand and the resale value of assets (one, unless personal guarantees and assets increase the amount available for loan).

2. For private equity investments, the angel investor is likely to want to see others involved in the syndication. More active investors are likely to act like managing partners and will expect a say in or veto rights over contracts, investments, and other business decisions.

3. For venture investments, preferred stock rights that allow prior rights to distributions, loan or other secured positions to make the investment bankruptcy remote (when possible), preferred stock rights to change management in portfolio companies, and a variety of rights (e.g., “tagalong” rights to participate in any later investment or public funding round) will be secured to ensure as far as possible maximum protection for the capital source and its investors. Venture capital organizations themselves are usually organized as limited partnerships or manager-managed limited liability companies with equity investments from university pension funds, employee stock option plans, or other not-for-profit entities.

LLCs can be organized to fit investor control, control by parent organizations, organizer control (for LLCs with purposes similar to trusts, whose purposes and actions are determined by the settlor of the trust), or other control and management arrangements appropriate to the for-profit or not-for-profit purpose required in the course of drafting and negotiation of the LLC instrument.

Equivalent control arrangements are possible in other business organizations but may be more difficult to manage without liability risks for investors (in, for example, limited partnerships

in which management by limited partners produces general partnership status with resulting liability) or multiple types of agreements and documentation (in business corporations in which closely held organizations need articles of incorporation, bylaws, shareholders voting agreements, buy-sell agreements, and other documents detailing internal and external business relationships, all of which can be included in the LLC articles of organization and provisions of the operating agreement).

B. [3.410] Management

Illinois limited liability companies can be member-managed or manager-managed. See 805 ILCS 180/15-1. This means that the default rule is per capita voting; i.e., one member or one manager gets one vote, and a majority of members or managers can make and enforce a decision unless a unanimous vote is required. The default rule in corporations is per capital; i.e., one dollar value of shares is beaten by two dollars’ worth and so on, with percentages of ownership determining decisions, unless preferred share rights or other membership class rights lead to a different result.

Practitioners should carefully read 805 ILCS 180/15-1 and 180/15-5 to understand the differences between member-managed (looks like a partnership) and manager-managed (looks like a limited partnership) variants in LLC entity management authority and default rules.

The Limited Liability Company Act provides for variation of control provisions and other elements of management by agreement. See 805 ILCS 180/15-5. The section has been the basis of decisions in both federal and state courts. In Thorpe v. Levenfeld, No. 04 C 3040, 2005 WL 2420373 (N.D.Ill. Sept. 29, 2005), the defendants argued that, based on §15-5(b)(6)(A), the plaintiff was to allege that the operating agreement was manifestly unreasonable in order to plead a claim for breach of fiduciary duty properly. The court held, however, that the defendants’ argument was not well taken. Because the defendants did not direct the court to any provisions in the agreement that set out “specific types of categories or activities” that did not violate fiduciary duties, the court failed to see why the plaintiff should be required to plead that such provisions were manifestly unreasonable. 2005 WL 2420373 at *4, quoting 805 ILCS 180/15-5(b)(6)(A). The defendants’ motion to dismiss the breach of fiduciary duty claim on this ground was denied.

In Katris v. Carroll, 362 Ill.App.3d 1140, 842 N.E.2d 221, 299 Ill.Dec. 482 (1st Dist. 2005), the court rejected a collusion argument for veil-piercing against an LLC member who had no managerial duties under the operating agreement of a manager-managed LLC. It was held that the trial court properly granted summary judgment to the manager and the company on the LLC manager’s claim that the manager and company colluded with the member of the LLC to breach fiduciary duties allegedly owed to the LLC or LLC manager. The only way that the member could have breached any alleged fiduciary duty to them would have been to have had managerial authority pursuant to the LLC’s operating agreement, and the undisputed facts showed that he did not have such authority.

The Operating Agreement, not the statute, governs where the agreement does not violate the statute, and is otherwise clear. The statute will be used to interpret the agreement only if the agreement is unclear. In re Lahood, No. 07-81727 (Bankr. C.D. Ill. 3/19/2009) (Bankr. C.D. Ill., 2009)

These provisions, read together, make the LLC a reasonably flexible instrument. Management can be vested in a single member-owner, in all the members with majority votes of individuals (or of capital shares) determining results, in committees of members or individual or group managers, in various classes of members or managers, or otherwise as appropriate for a particular deal. Officers and managers can be annually elected, permanently appointed (as is the case in limited partnerships), or otherwise designated. Fiduciary duties can be defined and limited as appropriate to the particular deal within the very general limits of good faith and fair dealing.

If the deal is large enough to permit enough time for counsel to determine the intentions of the parties or if the industry in question has accepted use of LLCs for investments, then almost any transactional arrangement can be accommodated in limited liability form.

C. Distributions

1. [3.421] Distributions in the Ordinary Course of Business

The ability of limited liability companies to have any number of different classes of members or managers and the variety of provisions permissible in LLC operating agreements means that, with very few limits, distribution rights can be structured to fit the requirements of any given business deal. If an income stream needs to be limited to repayment of a particular amount (as is common in covenants with corporate bondholders), this can be specified by creation of a membership class or by amendment of the operating agreement. If special management rights are needed, control and non-control interests can be specified by choosing a manager-managed entity form or by other specification in the agreement or the articles of organization.

The default rule for distributions, which can be varied by the operating agreement, is the following:

(a) Any distributions made by a limited liability company before its dissolution and winding up must be in equal shares.

(b) A member has no right to receive, and may not be required to accept, a distribution in kind. 805 ILCS 180/25-1.

The Limited Liability Company Act also provides for rights to repayment and for compensation in the event of a winding up of the LLC’s business, and these provisions can also be revised using the operating agreement:

(a) A limited liability company shall reimburse a member or manager for payments made and indemnify a member or manager for liabilities incurred by the member or manager in the ordinary course of the business of the company or for the preservation of its business or property.

(b) A limited liability company shall reimburse a member for an advance to the company beyond the amount of contribution the member agreed to make.

(c) A payment or advance made by a member that gives rise to an obligation of a limited liability company under subsection (a) or (b) of this Section constitutes a

loan to the company upon which interest accrues from the date of the payment or advance.

(d) A member is not entitled to remuneration for services performed for a limited liability company, except for reasonable compensation for services rendered in winding up the business of the company. 805 ILCS 180/15-7.

LLC operating agreements and articles of organization can be drafted to correspond to any distribution requirements appropriate to a not-for-profit, for-profit, or other nongovernmental transactional context. Thus, payments can be at the sole discretion of a trustee-like manager (for an equivalent to a spendthrift trust), in equal amounts at stated intervals (for an equivalent to an annuity contract), or as determined by managing members or a vote of managers, or they can be made only on dissolution (as is common for real estate limited partnerships).

2. [3.432] Distributions on Dissolution

Illinois limited liability companies can be dissolved in the manner described in 805 ILCS 180/35-1. (Cf. Tully v. Mclean, 409 Ill.App.3d 659, 948 N.E.2d 714, 350 Ill.Dec. 434 (Ill. App., 2011, held, dissolution required upon event specified in Operating Agreement.) As a practical matter, when there is a continuing business, the remaining members will vote to continue the business without dissolution unless they are willing to realize capital gain or loss for income tax purposes or the administrative costs of continuing the entity exceed the tax or income benefits of continuation. The operating agreement can and should provide for buy-sell agreements to cover costs of capital repayment and income distribution on member resignation, bankruptcy, disability, death, or other events of separation; should provide agreements specifying priorities on distribution; and should allocate responsibilities for management and winding up, together with any compensation due for these activities. “Key man” insurance to cover death or disability repurchase of member interests that is deductible by the organization (while life or disability insurance purchases are not deductible from individual taxable income) is advisable if organizational income levels make the cost of premiums affordable.

Note that P.A. 93-59 (eff. July 1, 2003) amended the Limited Liability Company Act’s provisions for continuation of the entity after dissolution to allow members some time to make the decision not to dissolve. 805 ILCS 180/35-3(c).

The Business Corporation Act of 1983 allows issuance of fractional shares by board action, which means a majority can cash out a minority owner by paying the fair value of the shares. 805 ILCS 5/6.15. See also Teschner v. Chicago Title & Trust Co., 59 Ill.2d 452, 322 N.E.2d 54 (1974). To do this in an LLC, you would need a court determination allowing dissolution or dissociation under 805 ILCS 180/35-1. Such judicial process is extremely uncertain, and the date for dissolution would not be known until that of the court decree, making exact valuations and provision for cash flow to pay off the minority members difficult. Organizers and members would do much better to provide for orderly processes for majority or mutual decisions to separate, valuation of member holdings, and payout of such holdings as are to be transferred.

VIII. [3.443] PRE-ORGANIZATION AGREEMENT

A pre-organization agreement is advisable to define initial contribution obligations (and the tax basis for individuals and for the organization), to specify the legal basis of operations pending state acceptance of registration, and to protect the attorney drafting the operating agreement from charges of malpractice, all in the event that a deal falls apart before state approval of the articles of organization and before final execution of the operating agreement. No agreement may be needed if business operations, receipt of funds, and related functions will follow the execution by all members of the operating agreement of the limited liability company.

The basic elements of a pre-organization agreement include

a. a proposed name and the nature of the organization;

b. the names, addresses, phone numbers, and social security numbers or employer identification numbers of initial members and managers;

c. information concerning the initial contributions by members, including the type of payment, when it is payable (immediately, upon execution of the operating agreement, by installments, etc.), under what conditions payment is due, the valuation of payments, and the evidence of valuation required;

d. the nature of interests obtained by contributions (may be a brief reference to a number of member interest units with further reference to the valuation and management authority given the units in the operating agreement; under another model, could indicate “one member, one vote” authority; or could simply refer to the management provisions of the operating agreement and allow them to govern regardless of whether they are accepted for registration by the Secretary of State);

e. authorization of specific (or, alternatively, any) members to act as organizers for the purpose of filing the articles of organization for state registration of the LLC;

f. authorization for multiple signed copies of the agreement to have the same effect as a single instrument with signatures appended; and

g. the business operations, liabilities, and management authority pending acceptance of the LLC registration by the Secretary of State, which could provide that the members are to be governed by the operating agreement as a partnership agreement, pending initiation of LLC statute coverage by acceptance of registration.

CAVEAT: Concerning the initial contributions described above, contributions of services in exchange for membership interests may result in (a) an accrual of ordinary income to the member contributing services for LLCs organizing as partnerships and (b) a possible taxability of the organization for failure to meet the 80-percent control test under Code §351 for LLCs organizing as corporations for federal tax purposes. See Code §368(c). A contribution of property along with services may avoid the latter result, though disproportion between property contributions and interests assigned should not be unreasonable.

IX. [3.454] RESERVATION OF NAME

Section 1-15 of the Limited Liability Company Act specifies who may apply for reservation of the name of a limited liability company (basically, domestic or foreign LLCs, potential organizers for an LLC, and persons intending to apply for admission to transact business for foreign LLCs) and provides that the reservations last for 90 days. 805 ILCS 180/1-15. The filing fee is $300 for the initial registration and $100 for transfer of the reservation of a name. 805 ILCS 180/50-10(b).

Drafters should remember that acceptable LLC names are governed by §1-10 of the LLCA, which makes it clear that

[n]othing in this Section or Section 1-20 shall abrogate or limit the common law or statutory law of unfair competition or unfair trade practices, nor derogate from the common law or principles of equity or the statutes of this State or of the United States of America with respect to the right to acquire and protect copyrights, trade names, trademarks, service marks, service names, or any other right to the exclusive use of names or symbols. 805 ILCS 180/1-10(b).

Therefore, a cautious drafter will both conduct searches on all relevant trademark and other registers for these matters prior to recommending a name and ensure that any needed additional reservations or registrations appropriate to exclusive legal availability and use of the intended name are present upon organization.

Filing for reservation of a name is not a necessary precondition for acceptance for the filing of Form LLC-5.5, Articles of Organization, or Form LLC-45.5, Application for Admission to Transact Business, which provides a continuing right to domestic or foreign LLC names with the Secretary of State. For some clients, saving the additional $300 fee may be more important than ensuring availability of a specific designation. The form to use is Form LLC-1.15, Application to Reserve a Name, which is available along with the above forms on the Secretary of State’s website at www.sos.state.il.us/departments/business_services/publications_and_forms/llc.html.

X. ARTICLES OF ORGANIZATION

A. [3.465] In General

Given the variability of circumstances under which a limited liability company is organized, from two-person farms to corporate joint ventures, with and without managers, drafters are best advised to consider the minimum requirements of the Limited Liability Company Act and go through the Secretary of State’s Form LLC-5.5, Articles of Organization, with these in mind, adapting text to the Act and the details of the clients. Form LLC-5.5 and other Illinois LLC official filing forms as specified by the Office of the Secretary of State are available at www.sos.state.il.us/departments/business_services/publications_and_forms/llc.html. The Secretary of State’s A Guide for Organizing Domestic Limited Liability Companies, www.cyberdriveillinois.com/publications/pdf_publications/c334.pdf, has specific suggestions for what to put into Form 5.5 and what causes such filings to be rejected.

B. [3.476] Filing Form LLC-5.5

The address at which to file Form LLC-5.5, Articles of Organization, is Secretary of State, Department of Business Services, Limited Liability Division, Room 351 Howlett Building, 501 S. Second St., Springfield, IL 62756. The form must be filed in duplicate along with a filing fee of $500 payable to the Secretary of State by certified check, cashier’s check, Illinois attorney’s check, Illinois CPA’s check, or money order. See 805 ILCS 180/50-10(b)(1). This form is available, along with other Illinois limited liability company forms, at www.sos.state.il.us/departments/business_services/publications_and_forms/llc.html. Form LLC-5.5 can be filed online if credit card and expedited services fees are paid.

1. [3.487] Question 1 — Limited Liability Company Name

Section 1-10 of the Limited Liability Company Act provides:

(a) The name of each limited liability company as set forth in its articles of organization:

(1) shall contain the terms “limited liability company”, “L.L.C.”, or “LLC”, or, if organized as a low-profit limited liability company under Section 1-26 of this Act, shall contain the term “L3C”;

(2) may not contain a word or phrase, or an abbreviation or derivation thereof, the use of which is prohibited or restricted by any other statute of this State unless the restriction has been complied with;

(3) shall consist of letters of the English alphabet, Arabic or Roman numerals, or symbols capable of being readily reproduced by the Office of the Secretary of State;

(4) shall not contain any of the following terms: “Corporation,” “Corp.,” “Incorporated,” “Inc.,” “Ltd.,” “Co.,” “Limited Partnership” or “L.P.”;

(5) shall be the name under which the limited liability company transacts business in this State unless the limited liability company also elects to adopt an assumed name or names as provided in this Act; provided, however, that the limited liability company may use any divisional designation or trade name without complying with the requirements of this Act, provided the limited liability company also clearly discloses its name;

(6) shall not contain any word or phrase that indicates or implies that the limited liability company is authorized or empowered to be in the business of a corporate fiduciary unless otherwise permitted by the Commissioner of the Office of Banks and Real Estate under Section 1-9 of the Corporate Fiduciary Act. The word “trust”, “trustee”, or “fiduciary” may be used by a limited liability company only if it has first complied with Section 1-9 of the Corporate Fiduciary Act;

(7) shall contain the word “trust”, if it is a limited liability company organized for the purpose of accepting and executing trusts; and

(8) shall not, as to any limited liability company organized or amending its company name on or after April 3, 2009 . . . , without the express written consent of the United States Olympic Committee, contain the words: (i) “Olympic”; (ii) “Olympiad”; (iii) “Paralympic”; (iv) “Paralympiad”; (v) “Citius Altius Fortius”; (vi) “CHICOG”; or (vii) “Chicago 2016”.

(b) Nothing in this Section or Section 1-20 shall abrogate or limit the common law or statutory law of unfair competition or unfair trade practices, nor derogate from the common law or principles of equity or the statutes of this State or of the United States of America with respect to the right to acquire and protect copyrights, trade names, trademarks, service marks, service names, or any other right to the exclusive use of names or symbols.

(c) (Blank).

(d) The name shall be distinguishable upon the records in the Office of the Secretary of State from all of the following:

(1) Any limited liability company that has articles of organization filed with the Secretary of State under Section 5-5.

(2) Any foreign limited liability company admitted to transact business in this State.

(3) Any name for which an exclusive right has been reserved in the Office of the Secretary of State under Section 1-15.

(4) Any assumed name that is registered with the Secretary of State under Section 1-20.

(5) Any corporate name or assumed corporate name of a domestic or foreign corporation subject to the provisions of Section 4.05 of the Business Corporation Act of 1983 or Section 104.05 of the General Not For Profit Corporation Act of 1986.

(e) The provisions of subsection (d) of this Section shall not apply if the organizer files with the Secretary of State a certified copy of a final decree of a court of competent jurisdiction establishing the prior right of the applicant to the use of that name in this State.

(f) The Secretary of State shall determine whether a name is “distinguishable” from another name for the purposes of this Act. Without excluding other names that may not constitute distinguishable names in this State, a name is not considered distinguishable, for purposes of this Act, solely because it contains one or more of the following:

(1) The word “limited”, “liability” or “company” or an abbreviation of one of those words.

(2) Articles, conjunctions, contractions, abbreviations, or different tenses or number of the same word. 805 ILCS 180/1-10.

The Illinois Administrative Code adds the following requirements and specifies the following results for the name application and filing process:

a. Regarding the statutory requirements of the name application, 14 Ill.Admin. Code §178.100 provides:

A proposed limited liability company name shall comply with the applicable provisions of the LLCA.

b. Regarding a preliminary determination of the availability of a name, 14 Ill.Admin. Code §178.105 provides:

Requests for searches of the records of the Secretary of State, Department of Business Services, Limited Liability Company Division, for a preliminary determination of the availability of a proposed name will only be accepted through the Springfield office of the Department. Requests may be made over the counter, by letter, or by telephone and will be answered by the same[;] however, no more than three searches may be requested by a single telephone call. A preliminary determination of availability shall be informational only and shall not be deemed a final determination for any purpose.

c. Regarding the final determination of the availability of a name, 14 Ill.Admin. Code §178.110 provides:

A final determination whether a proposed name is available as a limited liability company name shall be made only upon payment of the proper fees as listed in Section 5-10 of the Act and the submission of a document required to be filed with the Secretary of State, stamped and filed with the Department of Business Services, Limited Liability Company Division.

d. Regarding a response as to the basis of the unavailability of a name, 14 Ill.Admin. Code §178.115 provides:

Any final determination or any preliminary determination under this Subpart that indicates a proposed name is unavailable shall specify a reason therefor when a document has been properly submitted or when a request in writing has been made, and has specifically requested that a reason for unavailability be stated. Only one reason for unavailability need be stated and, when appropriate, only one conflicting name need be set forth. Any stated reason for unavailability made with respect to a preliminary determination shall be informational only and shall not be deemed a final determination for any purpose.

e. Regarding the procedure for reconsidering a final determination, 14 Ill.Admin. Code §178.120 provides:

An applicant may request reconsideration of a final determination that a proposed name is unavailable, by making a written request addressed to the Director, Room 328, Howlett Building, Springfield, Illinois 62756. The applicant shall attach to this request a copy of the written final determination rejecting the name, and shall include a statement of the reasons upon which the applicant seeks approval of the name. The applicant may include material in support of the request for reconsideration. This reconsideration procedure shall not apply to any request for preliminary determination of availability. Only after the Director’s determination of unavailability shall an applicant be entitled to a hearing.

f. Regarding the effect of a final determination, 14 Ill.Admin. Code §178.125 provides:

A final determination under this Subpart that a limited liability company name is available is concerned solely with the administrative convenience of the Department of Business Service, Limited Liability Company Division and does not warrant the name selected or guarantee the unqualified use of the name without regard to the rights of other parties. The Secretary of State does not pass upon the legality of a limited company name by merely permitting organization, qualification, reservation or registration under a name. A final determination of limited liability company name unavailability shall not be based on deceptiveness, confusing similarity or other such considerations derived from unfair competition and trademark law.

g. Regarding the standards for conflicting names, 14 Ill.Admin. Code §178.130 provides:

A limited liability company name shall be distinguishable upon the record of the Secretary of State, Department of Business Services, Limited Liability Company Division, from the limited liability company name or any assumed limited liability company name of any domestic or foreign limited liability company or domestic or foreign corporation name or assumed name in existence and on record or from any name reserved or registered.

h. Regarding the definition of “distinguishable,” 14 Ill.Admin. Code §178.135 provides:

A limited liability company name is distinguishable when containing a difference from other names on the record. A difference exists when the limited liability company name distinguishability is recognizable by the Secretary of State or his/her designee.

i. Regarding matters that are not considered in the availability of a name, 14 Ill.Admin. Code §178.140 provides:

Only the proposed name and the names of active limited liability companies or corporations (limited liability companies or corporations that have not been dissolved or revoked) are considered in determining name availability. Among the matters not considered are:

a) the purpose, location or relative size of the business;

b) the intent of the applicant;

c) any consent by a limited liability company or corporation bearing a similar title;

d) the names of other unincorporated entities;

e) the common law or statutory law of unfair competition, unfair trade practices, trade marks, trade names, service marks, service names, copyrights or any other right to the exclusive use of names or symbols;

f) the names of limited liability companies or corporations not on record with the Secretary of State;

g) whether the public may be likely to be deceived or misled by the resemblance of the proposed name to the name of other limited liability companies or corporations;

h) whether an existing limited liability company or corporation may possibly be injured by a resemblance of the proposed name;

i) any criteria of sound, including, but not limited to, phonetics derived from deliberate misspelling or otherwise.

j. Regarding significant differences between names, 14 Ill.Admin. Code §178.145 provides:

Limited liability company names are deemed not to be distinguishable when a comparison of the names reveals no difference except for:

a) one or more of the following: limited liability company, LLC, L.L.C., corporation, company, incorporated, limited, or an abbreviation thereof, regardless of where in the name such may appear;

b) the inclusion or omission of punctuation, articles of speech, conjunctions, contractions (or symbols thereof), prepositions, or a letter or letters;

c) an abbreviation versus a spelling out of a word; a different tense of a word; or the use of the singular as opposed to the plural of a word.

k. Regarding surnames, 14 Ill.Admin. Code §178.150 provides:

A surname shall be considered a “word”. Where a limited liability company name consists of a surname without a given name or initials, it is treated in the same manner as other words for application of this Subpart. A person may use his or her own name in a limited liability company name, but the limited liability company name must still be distinguishable from other limited liability company names.

l. Regarding initials or combinations of letters, 14 Ill.Admin. Code §178.155 provides:

Where a name or portion of a name consists of initials only or letters of the alphabet, the combination of initials or letters of the alphabet will be treated as a “word” in the same manner as other words for application of this Subpart.

m. Regarding government affiliation, 14 Ill.Admin. Code §178.160 provides:

No name may falsely imply governmental affiliation.

n. Regarding restricted or professional words, 14 Ill.Admin. Code §178.165 provides:

a) Words which are subject to restrictions on their use in a limited liability company name include, but are not limited to, the following and any variation thereof: Insurance, Surety, Underwriters, Bank, Bankers, Banking, or any licensed professional services.

b) However, “Bank”, “Banker”, or “Banking” may be used in a limited liability company name if, at the time of filing of the articles of organization, application for admission by a foreign limited liability company, or an amendment to either of these documents to change the limited liability company name, the limited liability company shall give the Department a letter signed by the Director of Financial and Professional Regulation — Division of Banking or a designee granting permission to use these words, pursuant to the standard set forth in Section 46 of the Illinois Banking Act.

1) The limited liability company using any of these aforementioned words must not be engaged in the banking business, but may be a bank holding company.

2) The use of these words shall be allowed if the limited liability company is not conducting financial business and the otherwise prohibited word is a person’s proper name, e.g. “Robert Banks”.

c) The Department will prohibit the organization of limited liability companies which seek to use names or have purposes which violate the Act. This prohibition does not apply to names or purposes specifically authorized by these rules.

o. Regarding acceptable print characters, 14 Ill.Admin. Code §178.170 provides:

The limited liability company name must consist of letters of the English alphabet, Arabic or Roman numerals, and/or symbols capable of being readily reproduced by the Office of the Secretary of State.a) Letters of the English alphabet include upper case or capital letters only; no distinction as to type face or font is recognized.

b) Arabic numerals include: 0, 1, 2, 3, 4, 5, 6, 7, 8, 9

c) Roman numerals characters include: I, V, X, L, C, D, M

d) Symbols recognized by the Secretary of State include: @ # $ % & * ( ) _ + = : “ ; / ? , . [Emphasis in original.]

2. [3.498] Question 2 — Address of LLC’s Principal Place of Business

Section 5-5(a) of the Limited Liability Company Act provides, “The articles of organization shall set forth . . . the address of [the LLC’s] principal place of business which may, but need not be a place of business in this State.” 805 ILCS 180/5-5(a). Note that merely specifying a post office box or c/o address alone is not acceptable.

3. [3.5049] Question 3 — Date That Articles of Organization Are Effective

The effective date of the articles of organization can be the date they are accepted for filing or up to 60 days thereafter. 805 ILCS 180/5-5(b). A later date could be useful to put all company operations in a specific fiscal or calendar year, to match a buy-sell transaction date, or to fit capital contributions and closing dates specified in a pre-organization agreement.

4. [3.510] Question 4 — Registered Agent’s Name and Registered Office Address

A registered agent’s name and address must be included in the articles of organization. 805 ILCS 180/5-5(a)(3). Post office box or c/o addresses are unacceptable. The agent must be an individual resident of this state, a domestic corporation, or a foreign corporation having a place of business in and authorized to do business in this state. 805 ILCS 180/1-35(a). If the agent is a corporation, the corporation must be authorized by its articles of incorporation to act as an agent. Section 1-40(a) of the Limited Liability Company Act specifies that the following business records be kept at the limited liability company’s principal place of business:

(1) A list of the full name and last known address of each member setting forth the amount of cash each member has contributed, a description and statement of the agreed value of the other property or services each member has contributed or has agreed to contribute in the future, and the date on which each became a member.

(2) A copy of the articles of organization, as amended or restated, together with executed copies of any powers of attorney under which any articles, application, or certificate has been executed.

(3) (3) Copies of the limited liability company’s federal, State, and local income tax returns and reports, if any, for the 3 most recent years.

(4) Copies of any then effective written operating agreement and any amendments thereto and of any financial statements of the limited liability company for the 3 most recent years. 805 ILCS 180/1-40(a).

The registered agent is the LLC’s primary agent for service of process. 805 ILCS 180/1-50(a). A registered agent is appointed by the company (805 ILCS 180/1-5) and may be designated in an application for reinstatement following administrative dissolution (805 ILCS 180/35-40(b)(4)).

5. [3.521] Question 5 — Purposes for Which LLC Is Organized

Secretary of State Form LLC-5.5, Articles of Incorporation, www.sos.state.il.us/departments/business_services/publications_and_forms/llc.html, contains formation language allowing all activities that may lawfully be performed as LLCs. The addition of banking or other prohibited activity types can cause rejection of a filing.

Note that inclusion in the articles of organization of the business code from IRS Form 1065, U.S. Return of Partnership Income, for a specific line of business (such as any of the “Retail Trade” codes) may trigger tax reporting and scrutiny (e.g., the retailers’ occupation tax). Section 5-5(a)(2) of the Limited Liability Company Act provides that the articles of organization shall contain “[t]he purposes for which the limited liability company is organized, which may be stated to be, or to include, the transaction of any or all lawful businesses for which limited liability companies may be organized under this Act.” 805 ILCS 180/5-5(a)(2).

6. [3.523] Questions 6 and 7 — Dissolution

Section 5-5(a)(6) of the Limited Liability Company Act specifies that the articles of organization shall contain “[t]he latest date, if any, upon which the limited liability company is to dissolve and other events of dissolution, if any, that may be agreed upon by the members under Section 35-1 hereof.” 805 ILCS 180/5-5(a)(6). Note that the duration may be perpetual, and the use of a termination date no longer has relevance for federal qualification for pass-through tax status. Cautious drafters will specify perpetual duration unless the LLC is designed for estate tax or cash out on dissolution purposes (such as an LLC structured like a real estate limited partnership). If a termination date is specified, drafters must be cautious about long-term client and attorney reminder systems so that appropriate amendments to the articles are filed prior to the final dissolution date if an extension is needed. If this is not done, the members of the organization would be subjected to personal liability for organizational debts as are partners in other general partnerships or members of other unincorporated associations. See §3.42 above for a discussion of the dissolution of an LLC under §35-1 of the LLCA.

7. [3.543] Question 8(a) — Management by Managers

Section 5-5(a)(4) of the Limited Liability Company Act specifies that if the limited liability company is to be managed by a manager or managers, the articles of organization shall contain “the names and business addresses of the initial manager or managers.” 805 ILCS 180/5-5(a)(4). If managers are to have management rights, these rights must be specified in the operating agreement and may be specified in the articles of organization. See 805 ILCS 180/15-1, 180/15-5(a), 180/5-5(a)(8). It may be useful to specify exactly which job titles have the right to contract or otherwise bind the organization to put creditors and other litigants on notice as to apparent authority issues. However, more complex governance questions should be dealt with in the operating agreement.

The exercise of managerial authority, or status as a manager, creates fiduciary duties not present from mere ownership of a membership interest in an LLC. The LLCA sets forth general standards for managers’ and members’ conduct at 805 ILCS 180/15-3. See also Katris v. Carroll, 362 Ill.App.3d 1140, 842 N.E.2d 221, 299 Ill.Dec. 482 (1st Dist. 2005). The courts can become

somewhat unreasonable at times, as in Federalpha Steel LLC Creditors’ Trust v. Federal Pipe & Steel Corp., 368 B.R. 679 (N.D.Ill. 2006), in which the court allowed proceedings against a member for failure to further capitalize an entity when another member was given management of the entity in the operating agreement despite 805 ILCS 180/10-10, without reference to whatever designation may or may not have been made as to whether the entity was manager-managed or member-managed in the articles of organization.

Designating authority as being vested in managers rather than in members means that the Securities Department of the Secretary of State’s Office will be alerted to the possibility that membership interests in the organization may require registration under the state’s blue-sky law (Illinois Securities Law of 1953, 815 ILCS 5/1, et seq.). The same will be true if, in a member-managed LLC, some of the members do not actively participate in management. The Securities Department has interpreted the blue-sky law to require registration of LLC membership interests. Following the test in Securities & Exchange Commission v. W.J. Howey Co., 328 U.S. 293, 90 L.Ed. 1244, 66 S.Ct. 1100 (1946), for securities requiring registration under §2(1) of the Securities Act of 1933, 15 U.S.C. §77a, et seq. (15 U.S.C. §77b(1)), the Department has applied 14 Ill.Admin. Code §130.201(a), which provides that the term “investment contract” includes but is not limited to “any interest or participation in a contract, transaction, scheme, common enterprise, or profit-seeking venture whereby the investor transfers capital to the promoter or promoters thereof or invests therein and looks to the promoter or promoters for the success of the venture.”

Counsel for closely held LLCs may wish to take advantage of the exemption from registration provided under §4G of the Illinois Securities Law for organizations with 35 investors or less. If so, Form 4G, Information Regarding the Filing of Reports of Sale Under Section 4.G of The Illinois Securities Law of 1953, www.sos.state.il.us/publications/pdf_publications/sec319_330.pdf, should be filed with the Securities Department. Section 4G of the Illinois Securities Law provides that the following types of transactions are exempt:

(1) Any offer, sale or issuance of a security, whether to residents or to non-residents of this State, where:

(a) all sales of such security to residents of this State (including the most recent such sale) within the immediately preceding 12-month period have been made to not more than 35 persons or have involved an aggregate sales price of not more than $1,000,000;(b) such security is not offered or sold by means of any general advertising or general solicitation in this State; and

(c) no commission, discount, or other remuneration exceeding 20% of the sale price of such security, if sold to a resident of this State, is paid or given directly or indirectly for or on account of such sales.

(2) In computing the number of resident purchasers or the aggregate sales price under paragraph (1)(a) above, there shall be excluded any purchaser or dollar amount of sales price, as the case may be, with respect to any security which at the time of its sale was exempt under Section 3 or was registered under Section 5, 6 or 7 or was sold in a transaction exempt under other subsections of this Section 4.

(3) A prospectus or preliminary prospectus with respect to a security for which a registration statement is pending or effective under the Federal 1933 Act shall not be deemed to constitute general advertising or general solicitation in this State as such terms are used in paragraph (1)(b) above, provided that such prospectus or preliminary prospectus has not been sent or otherwise delivered to more than 150 residents of this State.

(4) The Secretary of State shall by rule or regulation require the filing of a report or reports of sales made in reliance upon the exemption provided by this subsection G and prescribe the form of such report and the time within which such report shall be filed. Such report shall set forth the name and address of the issuer and of the controlling person, if the sale was for the direct or indirect benefit of such person, and any other information deemed necessary by the Secretary of State to enforce compliance with this subsection G. The Secretary of State shall prescribe by rule or regulation the amount of the fee for filing any such report, established pursuant to Section 11a of this Act, which shall not be returnable in any event. The Secretary of State may impose, in such cases as he or she may deem appropriate, a penalty for failure to file any such report in a timely manner, but no such penalty shall exceed an amount equal to five times the filing fee. The contents of any such report or portion thereof may be deemed confidential by the Secretary of State by rule or order and if so deemed shall not be disclosed to the public except by order of court or in court proceedings. The failure to file any such report shall not affect the availability of such exemption, but such failure to file any such report shall constitute a violation of subsection D of Section 12 of this Act, subject to the penalties enumerated in Section 14 of this Act. The civil remedies provided for in subsection A of Section 13 of this Act and the civil remedies of rescission and appointment of a receiver, conservator, ancillary receiver or ancillary conservator provided for in subsection F of Section 13 of this Act shall not be available against any person by reason of the failure to file any such report or on account of the contents of any such report. 815 ILCS 5/4G.

Counsel should also note and comply with the Illinois Business Brokers Act of 1995, 815 ILCS 307/10-1, et seq., the Illinois Loan Brokers Act of 1995, 815 ILCS 175/15-1, et seq., and §8 of the Illinois Securities Law, 815 ILCS 5/8, which require registration and reporting by business brokers, loan brokers, and investment advisors, respectively. Counsel should also know and make appropriate distinctions in their advice and activities between the practice of law and activities regulated under these Acts, designating reporting and registration requirements for these professions.

8. [3.554] Question 8(b) — Management by Members

Section 5-5(a)(5) of the Limited Liability Company Act specifies that if the limited liability company is to be member-managed, the articles of organization shall contain “the names and addresses of the initial member or members.” 805 ILCS 180/5-5(a)(5). Retention of significant member authority to manage the enterprise might avoid the passive activity loss limits that affect investors without general liability in limited partnerships. If member management authority in the

limited liability company is retained in whole or in part, directors and officers errors and omissions insurance coverage may be appropriate for these members.

Counsel may want to note in the articles of organization whether the members are to retain management in whole or in part. Section 5-1(b) of the LLCA specifies that an LLC “shall have one or more members.” Note that legal “persons” who can be members may include corporations, both domestic and foreign. 805 ILCS 180/1-5. Many LLCs could be joint ventures.

9. [3.565] Question 9 — Affirmation

Section 5-5(a)(7) of the Limited Liability Company Act specifies that the articles of organization shall contain “[t]he name and address of each organizer.” 805 ILCS 180/5-5(a)(7). Secretary of State Form LLC-5.5, Articles of Organization, www.sos.state.il.us/departments/business_services/publications_and_forms/llc.html, requires that the organizers of the LLC affirm their authority and the correctness of all statements made. Section 5-1(a) of the LLCA provides, “One or more persons, other than natural persons under 18 years of age, may organize a limited liability company. . . . The organizers need not be members of the limited liability company.” 805 ILCS 180/5-1(a).

Section 5-1(a) also specifies that each organizer of an LLC organized to practice medicine must be a licensed physician or an attorney admitted to practice in Illinois.

10. [3.576] Other Provisions for Regulation of Internal Affairs of LLC

The articles of organization may also contain “[a]ny other provision . . . for the regulation of the internal affairs of the limited liability company.” 805 ILCS 180/5-5(a)(8). This may include any provisions that “are required or permitted to be set out in the operating agreement of the limited liability company.” Id. What this means is that these provisions should specify any changes from the default rules of the Limited Liability Company Act that can be or must be in the articles of organization. These provisions, though directed to internal affairs, nevertheless can be important for clarification of apparent agency issues and other matters affecting outsiders.

For example, §13-5(a)(1) of the LLCA specifies that if members retain management, all instruments and documents signed by any member will be binding on the LLC unless obviously not in the ordinary course of business. Given the wide variety of interests and degrees of management participation and the authority that could be represented among those having a membership interest in an LLC, the drafters of the articles of organization may wish to craft terms of limitation that designate specific members or office holders for document execution (e.g., the chair, members of the executive committee, the LLC secretary, etc.) or otherwise track corporate practice rather than permit a continuation of apparent agency for all members per routine partnership forms.

More complex issues of member governance should be reserved to the operating agreement. Many of the default rules of the LLCA can be varied by either the articles of organization or the operating agreement. If use of the articles, which are a matter of public record, is desired, additional provisions to consider include a provision

a. eliminating or restricting a member’s right to lend money to and transact other business with the LLC;

b. requiring member approval by a simple majority or higher vote to amend the articles of organization;

c. for the admission of members without the unanimous consent of current members;

d. allocating the right to decide and the manner of decision by members of any matter and the requisite vote for approval;

e. for the management of the LLC by a manager and the manner in which members may elect this manager;

f. as discussed above, if the LLC is managed by members, restricting a member’s power to bind the LLC;

g. vesting in the managers and not members the right to adopt, alter, amend, or repeal the operating agreement of the LLC;

h. establishing indemnification rights for managers, employees, and agents of the LLC;

i. for the manner in which profits and losses are allocated and distributions are made to members;

j. restricting a member from resigning from the LLC (this could be a significant means of assuring the availability of investment capital until a settlement date as per current limited partnership practice);

k. permitting less than unanimous member consent to (1) permit a transferee or assignee of a membership interest in the LLC to participate in the management of the business and affairs of the LLC and (2) dissolve the LLC;

l. permitting the LLC to continue upon the vote of one or more members to continue; and

m. for the manner in which assets of the LLC shall be distributed upon dissolution of the LLC.

Remember that these provisions (except for authority limitations that may need notice to third parties by a public record) can and should be part of the operating agreement but need not be filed in the articles of organization, which is a record open for public access and which requires an organizational action and official filing (with accompanying fee) to amend.

11. [3.587] Transacting Business Under Assumed Name

If use of an assumed name is desired, Form LLC-1.20, Application to Adopt, Change, Cancel or Renew an Assumed Name, www.sos.state.il.us/publications/pdf_publications/llc120.pdf, must be filed with the Secretary of State. The filing fee is specified in the form, which also details the

applicable dates and legal requirements for assumed names. Foreign limited liability companies with names not otherwise permitted in Illinois under the Limited Liability Company Act and the Illinois Administrative Code must file for and use an acceptable assumed name. 14 Ill.Admin. Code §178.185.

XI. TAX REGISTRATION

A. [3.598] Unemployment Insurance

All new entities are required to file Form UI-1, Report to Determine Liability Under the Unemployment Insurance Act, www.ides.state.il.us/forms, with the Illinois Department of Employment Security. (http://www.ides.illinois.gov/Custom/Library/publications/Forms/ReporttoDetermineLiabilityUndertheUIAct.pdf; and see generally http://www.ides.illinois.gov/Custom/Library/publications/Publications/IllinoisUnemploymentInsuranceAct2.pdf, both visited January 14, 2013.) The UI-1 can also be filed, in simplified form, online. See https://taxnet.ides.state.il.us/Login/Help/RegistrationInstructions.pdf.

Religious organizations and organizations that do not have employees may be exempt from further reporting and withholding of unemployment insurance taxes. 820 ILCS 405/211.3A, 405/211.3B. Organizations that are not exempt are required to withhold and pay these taxes, regardless of whether the employees are executives or control persons not entitled to make claims for unemployment insurance benefits if separated from the organization. General information is available in the Illinois Department of Employment Security, Guide to the Illinois Unemployment Insurance Act (Oct. 2009), www.ides.state.il.us/publications.

B. [3.59] Business Tax Registration

New entities are required to register their existence and, if taxes may be due, to file estimated and annual or other returns for state income, retailers’ occupation, and other applicable state and local taxes. State tax registration is filed using Form REG-1, Illinois Business Registration Application, www.revenue.state.il.us/taxforms/index.htm. Drafters should be careful not to indicate that any sales will be made at retail, by vending machines, or by other manners that would trigger separate tax reporting requirements unless the organization is or will be engaged in this type of business.

XII. APPENDIX

A. [3.60] Pre-Organization Agreement

PRE-ORGANIZATION AGREEMENT

PURPOSE: Assignment of rights and duties precedent to organization pursuant to the Illinois Limited Liability Company Act of an enterprise to be known as ____________________, L.L.C. (hereinafter referred to as “the Company”). The Company will be authorized to transact any and all lawful businesses permitted under the Act.

https://taxnet.ides.state.il.us/Login/Help/RegistrationInstructions.pdf

http://www.ides.illinois.gov/Custom/Library/publications/Publications/IllinoisUnemploymentInsuranceAct2.pdf

http://www.ides.illinois.gov/Custom/Library/publications/Publications/IllinoisUnemploymentInsuranceAct2.pdf

http://www.ides.illinois.gov/Custom/Library/publications/Forms/ReporttoDetermineLiabilityUndertheUIAct.pdf

http://www.ides.illinois.gov/Custom/Library/publications/Forms/ReporttoDetermineLiabilityUndertheUIAct.pdf

MEMBER INTERESTS: The Company is to be governed by Articles of Organization and an Operating Agreement acceptable to the Members who make capital contributions as listed in Schedule A. Once these documents take effect, member interests and control rights shall be as specified in the Operating Agreement. Pending that date, the Company shall operate as a partnership with member voting rights proportional to their capital contributions to date.

PAYMENT OF CAPITAL CONTRIBUTIONS: Contributions are to be made upon execution of the Operating Agreement unless otherwise agreed by all or duly authorized Members. Contributions are to be in cash unless otherwise specified in Schedule A to this Agreement.

ORGANIZATION: Any one or more Members (if over 18 years of age) or one or more agents or attorneys-in-fact duly authorized by one or more Members over 18 years of age may execute Articles of Organization not inconsistent with this Agreement and may do or cause to have done any and all legal acts necessary to cause such Articles to be accepted for filing by the office designated for such filings under the Illinois Limited Liability Company Act.

NOTICE OF CLOSING DOCUMENTS: Copies of the Articles of Organization as filed, of all subscriptions to this Pre-Organization Agreement received to date, of the draft Operating Agreement, of any and all legally binding agreements made or agreed to be made on behalf of the Company to date, and of any balance sheets or other business documentation the organizers deem to be commercially reasonable are to be provided to all Members at least ten business days before the date scheduled for final receipt of capital contributions and subscription to the Operating Agreement.

ACCEPTANCE OF ARTICLES OF ORGANIZATION:

1. RIGHT TO WITHDRAW ON OR BEFORE CLOSING: In the event the Articles as filed or the Operating Agreement as drafted or the financial condition of the proposed business as indicated by the material provided by the Organizers shall be deemed unsuitable by any Member, that Member’s obligation to make capital contributions shall be excused upon delivery at or before closing of written notice of withdrawal to the organizer or organizers. Facsimile notices of withdrawal are acceptable if followed by signed and written verification.

2. RIGHT TO AMEND: The Articles of Organization, Operating Agreement, and any other agreements made to the date specified for subscription to the Operating Agreement (unless not legally amendable without the agreement of third parties) may be modified on or before that date by:

a. the unanimous written agreement of the Members who have subscribed to this Pre-Organization Agreement; or

b. the agreement of members representing a majority of all capital subscribed to date at a meeting for which at least five days’ written notice is provided to all Members.

Amendment after that date shall be as specified by the Operating Agreement.

EXECUTION: Separate copies of this Agreement may be signed with the same force and effect as though all signatures were part of and attached to the original instrument.

AGREED TO AND EXECUTED THIS __________ DAY OF _______________, 20__.

___________________________________Member

___________________________________Member

SCHEDULE A:MEMBER SUBSCRIPTIONS PROMISED:

NAME, ADDRESS, PHONE #, SSN OR FEIN AMOUNT SUBSCRIBED

1. $______________

Date(s) due:

Non-cash capital contributions, if any (describe property or services exactly, give valuation amount, and provide evidence of valuation):

2. $______________

Date(s) due:

B. [3.61] LLC Operating Agreement — Simple Form, Member-Managed

[COMMENT: This simple agreement sets forth the basic understanding and relationship between two parties coming together to form an LLC as equal members.]

OPERATING AGREEMENTOF

_________________________, L.L.C.

THIS AGREEMENT is hereby made and entered into this __________ day of _______________, 20__, by and between ____________________ and __________________, herein referred to together as the “Members,” both Illinois residents.

WITNESSETH:

WHEREAS, the Members, having mutual confidence in each other, have formed an Illinois Limited Liability Company (LLC) by filing Articles of Organization with the Secretary of State [insert any appropriate additional identification information, such as filing date, file number, and FEIN of the new LLC]; and

WHEREAS, the Members desire to set out and incorporate within this Agreement the terms and conditions on which the LLC is to be operated and the relationship of the Members thereto;

NOW, THEREFORE, for and in consideration of the mutual covenants and promises of the Members, the Members have agreed, and by these presents do agree, that they shall be Members on the terms and conditions hereinafter set forth:

1. Members. The Members, who shall in all respects be equal, are __________________ and ____________________.

2. Profits and Losses. The net profits of the LLC shall be divided equally between the Members, and the net losses shall be borne by them in equal proportions. Distributions shall be made at such time or times and in such amount or amounts as the Members shall agree.

3. Capital. The Members shall contribute in equal amounts whatever amount of capital that the LLC may require from time to time for its investments and operations and that the Members shall unanimously agree in writing to contribute. Failure to make such contributions at the agreed date or prior to such time shall constitute an election to dissolve the LLC and shall have the same effect as a written notice of election to dissolve as specified below. The initial contributions agreed to are stated in Appendix A to this Agreement. Any withdrawals of capital from the LLC shall be in such amounts and at such times as shall be agreed on by the Members.

4. Management. The Members each shall individually be authorized to act on behalf of the LLC in the conduct of its operations as the LLC’s agent. ____________________ shall be the “tax matters partner” (as defined in §6231(a)(7) of the Internal Revenue Code) for all appropriate federal tax purposes and such matters in connection therein. The Members shall have equal rights and responsibilities in the overall management policy of the LLC operations.

5. Voluntary Dissolution. Either Member may initiate a dissolution of the LLC after 30 days’ written notice to the other Member, in which case the affairs of the LLC shall be wound up as soon as is reasonably possible and all remaining assets shall be divided as provided for by law. The Members agree to prepare Articles of Dissolution once the winding up has occurred, and the LLC shall be dissolved upon the acceptance of the Articles of Dissolution for filing by the Secretary of State.

6. Death or Involuntary Dissolution. If one Member dies or other events of dissolution as specified by law occur, the remaining Member (or, if no Members remain, the personal representative or representatives of the Members) shall wind up the affairs of the LLC and file Articles of Dissolution as above specified for an event of voluntary dissolution.

7. Non-Assignability of Membership Interest. Neither of the Members shall sell, assign, pledge, mortgage, or otherwise transfer [his] [her] interest in the LLC without the written consent of the other Member.

8. Books of Account. The LLC shall maintain adequate accounting records reflecting, among other things, each Member’s capital account. All books, records, and accounts shall be open at all times to inspection by each of the Members.

9. Banking. All funds of the LLC shall be deposited in its name in an account or accounts in [bank or savings and loan association] or in such other financial institution(s) agreed on from time to time by the Members. Checks shall be drawn on the LLC account for LLC purposes only.

10. Amendment. This Agreement may be altered, amended, or terminated by a writing signed by both Members. In the event the LLC should be terminated by mutual agreement or by any other means, the Members shall proceed with reasonable promptness to liquidate the LLC and to file Articles of Dissolution and any other required state or federal documentation required to ensure an orderly termination.

11. Applicable Law. The LLC and this Agreement shall be governed by the laws of the State of Illinois.

IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement at ____________________, Illinois, on the day and date first above written.

___________________________________[name]

___________________________________[name]

Appendix A: Initial Capital Contributions Agreed

1. Member:Contribution agreed:Agreed valuation of contribution:Contribution due date:

2. Member:Contribution agreed:Agreed valuation of contribution:Contribution due date:

NOTE: This operating agreement assumes that all members are sufficiently active in the business to make their investments exempt from securities law requirements (e.g., registration if sales of securities are made to nonaccredited investors, etc.). The basic definition of a “security” includes interests in LLCs, but the registration requirements depend on the security’s function: Is this an investment that depends for value on the efforts of others, or is this really an asset purchase, or a business partnership, or a loan, or some other type of economic activity besides investment? If so, as the following cases show, the Illinois and federal authorities can be satisfied. If not, then their rules will apply.

(3.63) Operating Agreement, Illinois, Simple Form, Single Member

_____________ LLCOPERATING AGREEMENTThis agreement is made by the members named below for the operation and management of *name (the “company”).1.0 Organization1.1 Name. The name of the company is ___________ LLC. The name of the company may be changed or an assumed name adopted by majority vote.1.2 Form of business. The company is an Illinois limited liability company.1.3 Tax treatment. The company shall be taxed as a partnership.2.0 Offices and Registered Agent2.1 Registered Office. The company shall designate and continuously maintain a registered office in the State of Illinois. 2.2 Principal Office. The principal office of the company shall be that which is designated as such in its Articles of Organization or as subsequently determined by vote of the members.2.3 Other Offices. The company may also have other offices within and without the State of Illinois at such places as the members may from time to time determine. 2.4 Registered Agent. The company shall designate and continuously maintain a registered agent in the State of Illinois at its registered office.3.0 Members and Decisions3.1 Members. The members and their respective interests are set forth in Exhibit A.3.2 Management. The company will be managed by its members. 3.3 Agency. a. The members each shall individually be authorized to act on behalf of the company in the conduct of its operations as the agent of the company.b. The members shall at all times have a designated registered agent.c. The members may appoint other agents and/or subagents, employees, contractors, and others charged with some element of day-to-day operations of the company, subject to the management authority and direction of the members.d. *name is specifically authorized to act for the company.3.4 Respective interests. Each member’s voting rights, distribution rights, and all other rights and responsibilities shall be determined pro rata. “Pro rata” means determined in accordance with each member’s percentage ownership interest rather than giving each member equal weight or an equal distribution. Any reference to an action by the members or any distribution, capital call, or other quantifiable right or obligation shall mean pro rata.3.5 Decision making. Decisions will be made by the members acting by consensus or, at the request of any member, by a formal vote. In the absence of a request for a formal vote, any action taken with the knowledge of a member and without request for a formal vote will be deemed to be ratified by that member.3.6 Meetings.a. All meetings of the members shall be held at the principal office of the company, or at such other place as may be fixed by resolution of the members at any location or upon the high seas. Meetings may also be held by telephone, video conferencing, internet chat, or by email copied to all members or sent to all members through a listserve.b. Meetings will be held upon the call of members holding at least ten percent of all votes upon no less than five days notice.

c. A member’s attendance at a meeting waives objection to lack of notice or defective notice of the meeting unless the member at the beginning of the meeting or promptly upon arrival objects to holding the meeting or transacting business at the meeting; and d. Unless otherwise required by law, holders of membership interests representing a majority of the voting interests constitute a quorum. If a quorum is not present at a meeting, the members present or represented by proxy shall have the power to adjourn from time to time without notice other than announcement at the meeting until the requisite quorum is present or represented. e. Action on any matter voted on at a meeting is approved if a quorum exists and if the votes cast in favor of the action exceed the votes cast against the action. Voting may be in person or by proxy.3.7 Action by consent. Any action requiring a vote may be taken without a meeting by unanimous consent of the members evidenced by a writing. Such consent shall describe the action taken, be in writing, be signed by each member entitled to vote on the action, indicate each signing member’s vote or abstention, and be kept in the records of the company. 3.8 Indemnification. With respect to any and all liabilities that may arise from a member’s role in the management of the company, the company shall indemnify and advance expenses to each member and the member’s estate, heirs, successors, and personal representatives to the fullest extent allowed by the laws of the State of Illinois, both as now in effect and as hereafter adopted or amended. 3.9 Tax matters partner. *Name shall be the “tax matters partner” as defined in §6231(a)(7) of the Internal Revenue Code for all appropriate federal tax purposes and such matters in connection therein. A new tax matters partner may be appointed by vote of the members.3.10 Profits and losses. The profits and losses of the company shall be allocated among the members in proportion to each member’s ownership interest in the company.3.11 Distributions. Distributions shall be made at such time or times and in such amount or amounts as the members shall agree. Distributions shall be allocated among the members in proportion to each member’s ownership interest in the company.4.0 Records, Reports, and Transfer Restrictions4.1 Company records. The company shall keep the following records at the principal place of business of the company named in the articles of organization or at the registered office or at the office of the company’s lawyer or accountant. Such Records may be inspected and copied at the request and expense of any member or legal representative of a deceased member or member under legal disability during ordinary business hours. These records are:a. A record of all actions taken with or without a meeting (but not actions taken by consensus).b. Appropriate accounting records.c. A register of its current and former members documenting any sale or transfer of interests. d. A list of the full name and last known address of each member setting forth the amount of cash each member has contributed, a description and statement of the agreed value of the other property or services each member has contributed or has agreed to contribute in the future, and the date on which each became a member.e. A copy of the articles of organization, as amended or restated, together with executed copies of any powers of attorney under which any articles, application, or certificate has been executed.f. The company's federal, state, and local income tax returns and reports, if any, for the 3 most recent years.g. Any then effective written operating agreement and any amendments thereto and of any financial statements of the limited liability company for the 3 most recent years.h. A transfer register documenting all transfers of interest in the company.i. Any official filings.

4.2 Financial reports. The company will prepare annual financial statements that include a balance sheet as of the end of the fiscal year, an income statement for that year, a statement of changes in the members’ equity for the year, and such other information necessary to comply with the requirements of the applicable provisions of the Illinois Limited Liability Company Act or other applicable law. Any portion of this requirement may be waived by any member.

5.0 Issuance and Transfer of Membership Interests

5.1 Membership certificates. The company may provide membership interest certificates that shall be numbered and entered on the books of the company as they are issued. The certificates will show the class of membership interest, the holder’s name, the interest represented by the certificate, and the date issued. The certificates will be signed by individuals designated by vote of the members. However, there is no requirement that such certificates be issued. In the absence of such certificates, the records of the company will determine ownership interests.5.2 Lost certificates. In case of loss or destruction of a certificate of membership interest, no new certificate shall be issued in lieu thereof except upon satisfactory proof of the loss to the members. The members may require a bond or other security to protect against loss to the company. Any such new certificate shall have “duplicate” marked on its face. At the option of a member, the member’s certificates will be held with the records of the company with a photocopy issued to the member clearly marked as a duplicate.

5.3 Restrictions and limitations. Any certificates shall contain the following restrictions:

a. The ownership interests evidenced by this certificate are subject to the terms and conditions of an operating agreement which is available for inspection at the company’s principal place of business.b. The Membership Interests evidenced by this certificate are subject to restrictions on transfer pursuant to a written operating agreement as permitted by the Illinois Limited Liability Company Act, 805 ILCS 180/1-1, et seq., as amended. Copies of the agreement, in full, will be furnished by the company to any member upon request and without charge.c. The Membership Interests represented by this certificate have not been registered under any federal Securities Act or under the Securities Law of the State of Illinois, and such Membership Interests have been issued and acquired for investment purposes only. Such Membership Interests may not be sold, mortgaged, pledged, hypothecated, assigned, or otherwise transferred or encumbered without an effective registration statement for such Membership Interests under said Acts or an opinion of counsel for the company that registration is not required thereunder, and such transaction shall not endanger any exemption from registration on which the company may have relied.

5.4 Transfer of membership interests and rights of transferees. The rights against the company inherent in the membership interests represented by a certificate of membership interest in the company are transferable only by registration of such membership interests in the name of the assignee as the registered holder on the books of the company. In all cases of transfer, the former certificate shall be surrendered and canceled before a new certificate is issued. Membership interest may be transferred on the books of the company only by

a. Delivery of the certificate properly endorsed by the holder of record; or

b. Delivery of the certificate and a separate document containing a written assignment of the certificate by the holder of record or a proper written power of attorney to sell, assign, or transfer the same or the Membership Interests represented thereby.

c. Delivery of an instrument of transfer if no certificates are issued.

5.5 Restriction on Transfer. No interest in the company may be transferred, mortgaged, or pledged without the unanimous consent of the members. No interest in the company may be transferred by operation of bankruptcy or any judgment or other involuntary action against a member.

6.0 Capital Contributions

6.1 Initial capital. Each member shall contribute his or her share of capital as provided in each member’s pre-organization subscription. However, if this operating agreement has been signed by all proposed members, then each member shall contribute his or her share of capital as provided in Exhibit A. Membership in the company is conditioned upon making the required capital contribution by the date upon which it is due.6.2 Additional capital by majority vote. The company may raise additional capital by majority vote. Each member shall have preemptive rights to subscribe to additional capital provided payment is made under the terms of the additional capital offering.6.3 Additional capital by agreement. If unanimously agreed by all members, the company may require each member to contribute additional capital.6.4 Adjustment of ownership interest. The ownership interests where additional capital is needed shall be adjusted in accordance with a majority vote, subject to preemptive rights.6.5 Failure to make capital contributions. By vote of the remaining members, the company may take any one or more of the following steps with respect to unpaid capital contributions:a. Enforce the obligation.b. Suspend the member’s right to vote until the payment is made.c. Obtain the capital elsewhere with a corresponding dilution of the member’s interest in the company consistent with the terms of the capital call.d. Waive the member’s obligation with a corresponding dilution of the member’s interest in the company consistent with the terms of the capital call.6.6 Withdrawals. Any withdrawals of capital from the company shall be in such amounts and at such times as shall be agreed on by a majority of the members. No member shall have the right to withdrawal without such agreement.

7.0 Miscellaneous

7.1 Fiscal year. The fiscal year of the company shall be fixed by resolution of the members. In the absence of a resolution, the fiscal year shall be the same as the calendar year.7.2 Seal. The company shall have no seal. 7.3 Notice.. Notices shall be in writing and delivered to a member’s last known address, fax number, or email address as the case may be in person, by certified mail, by private delivery service, by fax, or by email. Notice is deemed given when sent.7.4 Negotiable instruments. All checks, drafts, notes, or other obligations of the company shall be signed by any member or by such other person(s), as may be authorized in writing by the members.

7.5 Deposits. Financial assets of the company may be deposited in the name of the company in such banks or financial institutions as the members shall designate from time to time and shall be drawn out by check signed by such members as set forth in resolutions delivered to such banks or institutions.7.6 Real estate. The company has full authority in its own name to own, transfer, lease, encumber, or convey real estate or any interest therein.7.7 Borrowing. The company may borrow money upon a vote of the members.7.8 Applicable law. This agreement and all matters affecting the company shall be governed by the law of the State of Illinois.7.9 Dispute resolution. Any dispute among the members, and any dispute between the company and any one or more of its members shall first be submitted to mediation before a mediator reasonably acceptable to all parties. All parties will share in the cost of mediation on a per capita basis. If mediation is not successful, the dispute shall be resolved by binding arbitration under the rules of the American Arbitration Association or such other arbitration service acceptable to all parties. Judgment may be entered upon the award. In the case of arbitration the prevailing party shall be entitled to an award of reasonable attorney’s fees and costs.

8.0 Amendment and Dissolution

8.1 Amendment. This operating agreement may be amended by vote of the members at any meeting of the members at which a quorum is present provided notice of intention to amend shall have been contained in the notice of such meeting. This operating agreement may also be amended by the members by unanimous consent.

8.2 Voluntary dissolution. The company shall be dissolved by unanimous consent or vote of the members. In the absence of a unanimous consent, at least 30 days notice of a meeting called to dissolve the company shall be given. If dissolution is approved the affairs of the company shall be wound up as soon as is reasonably possible and all remaining assets divided as in the case of a withdrawal. The members agree to prepare Articles of Dissolution once the winding up has occurred. The company shall be dissolved upon the acceptance of Articles of Dissolution for filing by the Secretary of State.

8.3 Death or involuntary dissolution. If one member dies, or other events of dissolution as specified by law occur, the remaining members (or, if no members remain, the personal representative or representatives of the members) shall wind up the affairs of the company and file Articles of Dissolution as above specified for an event of voluntary dissolution, unless a majority of the remaining members elect to continue the company.In witness whereof the parties have executed this operating agreement on the dates written.

Dated:

(x) _________________, Sole Member ____________________, LLCEXHIBIT A TO OPERATING AGREEMENTCompany Name_____________ LLC

Principal Place of Business: Per Articles of Organization filed ______________

Registered Agent and Registered office: Per Articles of Organization filed ______________

Date Organized

Member Allocation Table

Member Name Date of Contribution Form of Contribution CapitalContribution Percent

Ownership_________________ 00/00/0000 Cash $ 100 Cash $ % Cash $ %

Persons Authorized to Act for the Company

Taxpayer Identification Number

FEIN Is: ______________________________________

Business Purpose

The transaction of any or all lawful business for which limited liability companies may be organized under the Illinois Limited Liability Company Act.

(3.65) Member Interests Not Always Securities

The following transactions were not deemed to be security sales subject to the requirements of the Illinois Securities Law:

In Doherty v. Kahn, 289 Ill.App.3d 544, 682 N.E.2d 163, 224 Ill.Dec. 602 (1st Dist. 1997) (precedent overruled for independent contractor status determination, but not for what is or is not a security, by Byung Moo Soh v. Target Marketing Systems, Inc., 353 Ill.App.3d 126, 817 N.E.2d 1105, 288 Ill.Dec. 455 (1st Dist. 2004)), the transaction for the sale of stock in the plaintiff’s business was not a sale of securities, but rather a creation of a partnership in a corporate form as the plaintiff served as the president of the business and was responsible for client development, sales, and operations. The plaintiff’s profits were not solely from the effort of others.

In Space v. E.F. Hutton Co., 188 Ill.App.3d 57, 544 N.E.2d 67, 135 Ill.Dec. 710 (4th Dist. 1989), although the plaintiff was a purchaser, he was not a purchaser of securities, but rather a purchaser of advice and services that were not covered.

In Dahl v. English, 578 F.Supp. 17 (N.D.Ill. 1983), when the transaction was the sale of unique pieces of artwork to individual purchasers at different prices through different contracts executed at different times, although two purchasers bought products from the same seller, this failed to establish a pooling of funds as required for common enterprise; therefore, the transactions did not constitute securities and did not fall within the protection of the Securities Act.

C. Additional Resources

1. [3.62] Bibliography

Brown, Roger B. and Christopher D. Merrett, The Limited Liability Company Versus the New Generation Cooperative: Alternative Business Forms for Rural Economic Development, 11 Rural Research Rep., No. 7, 1 (Spring 2000) (notes eight-percent distribution limit for profits from new generation cooperative versus none for limited liability company).

Community Bankers Association of Illinois, A Guide to Organizing a New Bank in Illinois (2006), www.cbai.com/news/denovoguide.pdf.

Division of Banks and Real Estate, Illinois Department of Financial and Professional Regulation, Interpretive Letter 96-6 (Oct. 3, 1996), www.obre.state.il.us/cbt/legal/intrltr/btil9606.pdf (bank requirements).

Illinois Department of Commerce and Economic Opportunity, Starting Your Business inIllinois (1998), www.commerce.state.il.us/dceo/bureaus/entrepreneurship+and+small+business/publications.

Looker, Dan, Farmer bargaining groups make steady progress, 99 Successful Farming, No. 4, 9 (Mar. 2001).

Office of the Comptroller of the Currency, U.S. Department of the Treasury, Conditional Approval Letter No. 324 (Sept. 1999), www.occ.treas.gov/interp/sep99/ca324.pdf (cash management subsidiary).

Price, William A., LIMITED LIABILITY ORGANIZATIONS (Specialty Technical Publishers, 2001) (multistate and international guide to business and nonbusiness corporations, trusts, and LLCs and their organization, taxation, regulation, and economic development aspects).

Sayler, Tracy, “Next generation” co-ops springing up in U.S., 27 Prairie Grains (Mar. 2000), www.smallgrains.org/springwh/mar00/next/next.html.

2. [3.63] Internet Resources

www.commerce.state.il.us (Illinois Department of Commerce and Economic Opportunity)

www.ides.state.il.us (Illinois Department of Employment Security)www.irs.gov (Internal Revenue Service)

www.revenue.state.il.us (Illinois Department of Revenue)

www.sba.gov (U.S. Small Business Administration)

www.sos.state.il.us (Illinois Secretary of State)

www.value-added.org (Illinois Value Added Sustainable Development Center’s list of other Illinois agricultural producer and economic development groups)