LLC Operating Agreement changes when electing S status

Technical topics regarding tax preparation.
#1
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A SMLLC (taxed as a Schedule C) has been in business a few years and would like to elect S status effective 1/1/21. It is my understand the language and some provisions in the Operating Agreement have to be updated to avoid a second class of stock issue.

The Operating Agreement will be amended/updated by the attorney in the next few weeks and once completed the Form 2553 will be filed before March 15. Is there a potential problem that the Operating Agreement was amended after 1/1/21 and thus on 1/1/21 it would have contained old LLC language that could cause a S election invalidation if audited?
 

#2
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As long as it's made effective 1/1/2021, I think you're fine.

For a SMLLC, how would you have an operating agreement that would cause a 2nd class of stock issue? There's only one owner.
~Captcook
 

#3
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I'm not aware of a way there could be a second class of stock with only one owner. I was unsure whether the language, alone, in the Operating Agreement, regardless the number of members, was enough to invalidate the election.
Last edited by Taxalmancer on 13-Jan-2021 4:30pm, edited 1 time in total.
 

#4
JR1  
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I'm scratching my head that a SMLLC has a freakin' Operating Agreement! lol
Go Blackhawks! Go Pack Go!
Remembering our son, Ben Jan 22, 1992 to Aug 26, 2011.
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#5
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JR1 wrote:I'm scratching my head that a SMLLC has a freakin' Operating Agreement! lol


Had that same thought...
~Captcook
 

#6
sjrcpa  
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The OA may have been written with multiple members in mind. I have seen that for a SMLLC.
 

#7
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Every SMLLC OA I can remember was written with multiple members in mind.
 

#8
Pitch78  
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JR1 wrote:I'm scratching my head that a SMLLC has a freakin' Operating Agreement! lol



In my experience, banks require a written operating agreement regardless whether state law requires one.

As the good Capt said, date it effective 1/1/21 and you will be fine.
 

#9
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Pitch78 wrote:
JR1 wrote:I'm scratching my head that a SMLLC has a freakin' Operating Agreement! lol


In my experience, banks require a written operating agreement regardless whether state law requires one.


Every bank I have worked with for an LLC (regardless of taxation) only cares about a valid EIN and the Articles of Organization. Not quite the same as an OA...
 

#10
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CornerstoneCPA wrote:Every bank I have worked with for an LLC (regardless of taxation) only cares about a valid EIN and the Articles of Organization. Not quite the same as an OA...


Agreed.
~Captcook
 

#11
JR1  
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I can't recall ever a bank asking for Op Agreement.
Go Blackhawks! Go Pack Go!
Remembering our son, Ben Jan 22, 1992 to Aug 26, 2011.
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#12
sjrcpa  
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Me neither.
 

#13
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I see them ask just to open a bank account - KYC rules

Once a bank customer, the bank might not again ask for loans
 

#14
Nilodop  
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KFC never asks me, but they do know their customers. (KYC).
 

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And... their customers know them!
 

#16
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Taking a contrarian viewpoint here. Operating Agreements are always recommended. Especially if there's some risk of legal liability, which is the primary reason to create an LLC in the first place.

A plaintiff's attorney would have a field day with an LLC that doesn't have an Operating Agreement. And a charging order on an LLC without an Operating Agreement could potentially allow the creditor to do whatever they want or force the debtor to fight everything in court, depending of course on state law.
 

#17
Pitch78  
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Interesting responses. I have argued with bankers regarding the need for an operating agreement, and they all claimed it was required by the Patriot Act despite state law. I quit arguing with them because it just was not worth the effort. I do agree that an operating agreement should be done even with a SMLLC. Just a formality that may matter if other formalities are not followed.

Are you guys also saying that even if the LLC is a MMLLC that the bank does not require an operating agreement? How do they know who has authority?
 

#18
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I've never been required to provide an operating agreement for accounts I've opened for my own personal businesses.

Personally, I can usually talk my way through the management structure (i.e. BSing) enough that the banker just goes with it.

Usually all I've needed to do is provide a bank resolution. One time I was asked to provide a letter from a lawyer or CPA, but if I recall correctly that was because the bank didn't have a footprint in the state of organization.
 

#19
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There is an excellent article at the American Bar Association regarding this issue. My concern may be unfounded, but it was after reading this article, that my takeaway was the Operating Agreement language alone may be enough to invalidate a S election.

The discussion is about halfway down the article under "Subchapter S or Subchapter K" then continues in "Practice Points and Drafting":

https://www.americanbar.org/groups/business_law/publications/blt/2017/03/01_sheridan/

For those who subscribe to Checkpoint, there is a similar article about this issue in Federal Taxes Weekly, March 28,2013.
 

#20
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I've looked at several private letter rulings involving multi-member LLCs, taxed as a partnership, electing S status. If the effective date of S election is before the Operating Agreement is amended, the election is invalid.

Relief was granted in 202052003 and S election was allowed to the effective date of the S election as long as distributions had been made pro rata and the OA was updated. In PLR 201822003, a SMLLC elected S status and added a second shareholder at a later date. The OA was not updated at the time of the 2nd shareholder. The IRS allowed relief back to the date the 2nd shareholder entered the picture. No mention was made in the PLR about the time when the SMLLC had elected S status, also had bad language in the OA.

https://www.irs.gov/pub/irs-wd/202052003.pdf

https://www.irs.gov/pub/irs-wd/201822003.pdf

Do you think being a single-member LLC insulates it from being an invalid election even with bad language in the OA because there could not be a disproportionate distribution?
 

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