PLANNING AHEAD: Does my limited liability company really need an operating agreement?

An operating agreement serves as an instruction manual dictating the governance and operation of your limited liability company, or LLC. The purpose of an operating agreement is to: (i) preserve the limited liability status of your entity; (ii) specify rights and obligations between members; (iii) provide the necessary structure, accounting and tax provisions; (iv) identify policies in the event of disputes, the death or divorce of a member; and (v) set out the organizational governance for the LLC.

Currently, if there is no operating agreement, Florida law states that an LLC is subject to the default provisions provided for under Chapter 605, Florida Statutes. The risk of relying upon the default provisions in Chapter 605 is that these standard, default provisions may not align with the goals you have for your LLC or the agreement between the members.

To avoid relying upon the default provisions of Florida Statutes, I highly recommend that new business owners allocate time prior to the beginning of their LLCs existence to adequately prepare and draft an operating agreement. A clear and unambiguous agreement will help provide concise policies for distributing profits and losses, establishing a management structure, defining appropriate voting control and decision procedures, as well as resolving unforeseen disputes among members. Clear procedures will only further assist in the smooth operation and growth of an LLC. Such policies are also beneficial for planned and unexpected challenges, and typically can eliminate any confusion or ambiguity which may arise if relying upon Chapter 605.

Like its members, each LLC is unique, with each newly created LLC having its own set of specific goals and objectives that its members would like to accomplish. A good operating agreement should be structured to align with the ideals and objectives of the members of the LLC. Certain essential terms, including the following, should be included in all operating agreements:

  • Specifications regarding ownership percent or interest;
  • The rights and responsibilities of each member;
  • How to distribute profits and losses;
  • Voting rights (i.e. voting and non-voting membership interests; majority, supermajority or unanimous decisions);
  • Management hierarchy (i.e. appointment and removal of managers);
  • Termination, or dissolution, procedures;
  • Dispute resolution provisions;
  • Transfer restrictions;
  • Guidelines and parameters for borrowing money; and
  • How to remove an unruly director.

Business owners may draft and implement their own operating agreements; however, given that an operating agreement is an important legal contract that binds the members and the governance of the LLC, it is best to consult with an attorney who has experience in formation of business entities.

Dan Rich is an attorney with the law firm Clark, Campbell, Lancaster & Munson, P.A. in Lakeland.  Questions can be submitted to thelaw@cclmlaw.com.

When Does a Hobby Become a Business?

By: Clark, Campbell, Lancaster & Munson, P.A.

Do you have a hobby that has become profitable on eBay, Etsy, or social media? If so, the IRS may consider your hobby a business, and certain income tax consequences may result.

Q: What is the difference between a hobby and a business?

The IRS has provided the following nine factors a taxpayer should consider:

  1. Is the activity carried on in a businesslike manner?
  2. Does the time and effort put into the activity indicate an intent to make a profit?
  3. Does the taxpayer depend on the income from the activity?
  4. Are the losses from the activity beyond the taxpayer’s control?
  5. Has the taxpayer made changes to improve profitability?
  6. Does the taxpayer have the knowledge to carry the activity as a successful business?
  7. Has the taxpayer made a profit from similar activities in the past?
  8. Does the activity make a profit in some years?
  9. Does the taxpayer expect to make a profit in the future due to an appreciation of the assets used in the activity?

Overall, the key issue is whether a taxpayer treats the activity as a business and whether the taxpayer has an expectation of profit from the activity.

Q: If my hobby produces income, is it considered a business?

Not necessarily. A hobby can produce income even though the taxpayer does not have an expectation to make a profit. For example, a taxpayer enjoys painting swans on the weekends and frequently posts pictures of her paintings on social media. Taxpayer’s friend offers to buy a painting for $100. Taxpayer usually does not sell her paintings, but decides to take the $100. Taxpayer likely has a hobby because the taxpayer does not have an expectation to make a profit when she paints. However, if the taxpayer were to advertise her paintings for sale on social media, then the taxpayer may have a business.

Q: What are the tax consequences of a hobby and a business?

Regardless of whether the taxpayer has a hobby or a business, the taxpayer must report any income received. Therefore, in our example above, the taxpayer should report the $100 as income. A taxpayer may deduct the ordinary and necessary expenses from a hobby or business, but a taxpayer may not deduct a loss from a hobby. In our example above, assume the taxpayer spent $150 on painting supplies. If the taxpayer has a hobby, then the taxpayer may only deduct up to $100 on painting supplies as ordinary and necessary expenses because she received only $100 of income, and may not deduct a loss of $50. If the taxpayer has a business, then the taxpayer may deduct the full $150, which will result in a $50 loss.

Generally, the IRS is reluctant to find that a hobby qualifies as a business since a business may deduct losses. However, if a taxpayer treats the hobby as a business, such as maintaining a separate bank account and budget, forming a business plan, and keeping books and records, then it is more likely the IRS will find that the hobby qualifies as a business.