Attorney & CPA giving conflicting advice... help?
Los Angeles, CA · Member since 2016 · 43 posts · 9 votes
Hi BP,
I live in California and I'm forming an LLC with another person (who also lives in California) in order to buy 5-10 rental properties (small multis) this year in Kansas & Ohio.
My CPA is telling me that I should just create LLCs in Kansas & Ohio, and that I don't need to create one in CA - thus saving me the $800/yr fee.
My attorney is telling me that I absolutely need to create one in CA, and that the Franchise Tax Board will penalize me and I will pay more than the $800/yr. And that after I form an LLC in CA, I should just get business licenses in Kansas & Ohio whenever I buy.
It's really weird to hear such conflicting advice, so I'm hoping to hear some first hand experience from other members of BP.
How do you have your entity structured for out-of-state rentals?
Do you just have it where YOU live in, or just where the properties are, or both?
Also, do most people just create their entities over Legalzoom?
I work with a lot of out of state investors who are dealing with the same issue as you. Here is a response that I posted in the past about this subject with some relevant information on your situation:
As a California resident, you will still be subject to the California LLC franchise tax, even if your rental property is located outside California due to CA's broad interpretation of "doing business in California."
For example, Nick is a California resident and a member of a Nevada LLC that owns property in Nevada. The LLC hires a Nevada management company to collect rents and provide maintenance. Nick has the right to hire and fire the management company. He occasionally has telephone discussions from California with the management company in Nevada regarding the property. He is ultimately responsible for the property and oversees the management company. Nick is considered to be conducting business in California on behalf of the LLC. Accordingly, The LLC must file Form 568 and pay the franchise tax. (FTB 3556 LLC MEO (REV 01-2015).)
Accordingly, you can open a Ohio LLC but you will still have to register as a foreign business LLC in California because you are considered to be conducting business in California, merely by you having some management control of the property and being a CA resident. On the same token, if you setup a California LLC and you decide to transfer your Ohio property to the CA LLC, you will have to file as a foreign registered business in Ohio and pay the same fees as other Ohio LLCs because you are conducting business in Ohio.
Either way, you will have to pay the CA LLC franchise tax, along with the Ohio LLC tax/fee. You cannot simply obtain a business license in Ohio and run your California LLC in Ohio.
This can get expensive (primarily from CA's fees) so you will have to assess your cash flow situation to determine if it's worth it. However, I generally recommend using business entities for liability protection, especially if you plan to buy more properties. Overall, this is a decision based on risk averseness and cash flow.
Setting up the LLC is not too difficult and you may be able to figure it on your own and then have an attorney draft the Operating agreement. However, the forms can be a bit daunting and burdensome for many people, and they just feel more comfortable having an attorney take care of it. Let me know if you need additional help.
I am only licensed in California, so my interpretation of other states' laws are generalizations and may not apply to that particular state. You will have to consult a local attorney.
This response neither constitutes legal or tax advice nor establishes an attorney-client relationship. Inquirers must seek the advice of their own legal counsel prior to undertaking any course of action related to this inquiry.
If you are living in and doing any management of the LLC from CA you are going to be paying the CA Franchise tax of $800.
CA is extremely aggressive.
Thanks @Steven Hamilton II - ive heard this before a lot too. That makes sense now.
So just create an LLC in CA, and then acquire business licenses wherever you'd like to purchase?
Also, if my partner and I have a fairly straightforward 50/50 split, do most people still get attorneys involved for drafting operating agreements, or is our situation simple enough to use Legalzoom + some online operating agreement template?
@Victoria Townsend my first piece of advice is to fire your CPA. Even if you're LLC is not in CA, you still have to pay the $800 fee for the privilege of doing business in CA. Your CPA absolutely should know that.
When you form an LLC out of state, your LLC must have a personal representative that physically resides in that state. When you declined the IL LLC, where you could have been your own representative, your attorney offered to find someone in OH to act as your LLC's personal representative and perhaps take care of all the registration paperwork too..
I think you did not understand what the attorney was trying to do to protect your interests.
Not an LLC, and partnership where 1 member is in OH, so that wasn't the case.
My post was simply an observation about what I feel was happen in my situation. Maybe doesn't relate, and I'm certainly not an attorney.
Please don't use LegalZoom, if you are going to set up an entity, I highly recommend doing it through a lawyer. My husband and I set up an LLC in Texas, and we had an operating agreement created, even though we are doing a 50/50 split. It makes working with other companies easier as well.
Hi @Sarah Hale , just curious, why wouldn't you use Legalzoom to incorporate?
My hope was to create the entity through Legalzoom and then get an attorney for creating the operating agreement (in order to save some money on the incorporation process). Definitely interested in hearing why using an attorney would make it easier to work with other companies though !
would an attorney be able to create the LLC in a better way that protects your assets than creating the LLC through Legalzoom?
@Victoria Townsend I am not a lawyer/this is not legal advise...the problem with the websites like Legalzoom is that they may include something that isn't allowed in whatever state you are in, even though it asks where you are located. I have seen a few provisions in leases on one of those websites that wasn't allowed in my state.
I work with a lot of out of state investors who are dealing with the same issue as you. Here is a response that I posted in the past about this subject with some relevant information on your situation:
As a California resident, you will still be subject to the California LLC franchise tax, even if your rental property is located outside California due to CA's broad interpretation of "doing business in California."
For example, Nick is a California resident and a member of a Nevada LLC that owns property in Nevada. The LLC hires a Nevada management company to collect rents and provide maintenance. Nick has the right to hire and fire the management company. He occasionally has telephone discussions from California with the management company in Nevada regarding the property. He is ultimately responsible for the property and oversees the management company. Nick is considered to be conducting business in California on behalf of the LLC. Accordingly, The LLC must file Form 568 and pay the franchise tax. (FTB 3556 LLC MEO (REV 01-2015).)
Accordingly, you can open a Ohio LLC but you will still have to register as a foreign business LLC in California because you are considered to be conducting business in California, merely by you having some management control of the property and being a CA resident. On the same token, if you setup a California LLC and you decide to transfer your Ohio property to the CA LLC, you will have to file as a foreign registered business in Ohio and pay the same fees as other Ohio LLCs because you are conducting business in Ohio.
Either way, you will have to pay the CA LLC franchise tax, along with the Ohio LLC tax/fee. You cannot simply obtain a business license in Ohio and run your California LLC in Ohio.
This can get expensive (primarily from CA's fees) so you will have to assess your cash flow situation to determine if it's worth it. However, I generally recommend using business entities for liability protection, especially if you plan to buy more properties. Overall, this is a decision based on risk averseness and cash flow.
Setting up the LLC is not too difficult and you may be able to figure it on your own and then have an attorney draft the Operating agreement. However, the forms can be a bit daunting and burdensome for many people, and they just feel more comfortable having an attorney take care of it. Let me know if you need additional help.
I am only licensed in California, so my interpretation of other states' laws are generalizations and may not apply to that particular state. You will have to consult a local attorney.
This response neither constitutes legal or tax advice nor establishes an attorney-client relationship. Inquirers must seek the advice of their own legal counsel prior to undertaking any course of action related to this inquiry.
@Victoria Townsend, why do you need to be incorporated? Are you planning to take your company public in the future? I would reach out to a local Real Estate attorney that you have met at the REIAs. I am not familiar with California law, but here in Texas, you can file as an entity yourself for around $350. It won't save you time, but it'll save you money. And for LegalZoom, they cannot provide advice or guidance because they are not a law firm, they just prepare documents. I'd rather pay a little bit more money to file an entity with a lawyer because they can guide me.
But this is just my experience, I am not a lawyer/this is not legal advice...
An operating agreement is a custom document a simple template is not good enough for any venture. I've even seen issues in 130 page operating agreements.
You hit the nail on the head. Same is the case for those residents in CA that form and LLC in another state whereby the sole member is the IRA.
Hi BP,
I live in California and I'm forming an LLC with another person (who also lives in California) in order to buy 5-10 rental properties (small multis) this year in Kansas & Ohio.
My CPA is telling me that I should just create LLCs in Kansas & Ohio, and that I don't need to create one in CA - thus saving me the $800/yr fee.
My attorney is telling me that I absolutely need to create one in CA, and that the Franchise Tax Board will penalize me and I will pay more than the $800/yr. And that after I form an LLC in CA, I should just get business licenses in Kansas & Ohio whenever I buy.
It's really weird to hear such conflicting advice, so I'm hoping to hear some first hand experience from other members of BP.
How do you have your entity structured for out-of-state rentals?
Do you just have it where YOU live in, or just where the properties are, or both?
Also, do most people just create their entities over Legalzoom?
A business license in Kansas and Ohio is not enough. You'll need to "qualify" the CA LLC in those states by registering as a foreign LLC. It's a small fee, but it's what makes your entity legal in those states.
I owned many properties in Ohio and Michigan. I live in California. I liked Wyoming's LLC laws so I created my LLC's in Wyoming (as a domestic LLC), and registered them as foreign LLCs in Ohio and Michigan. I also registered them in CA as a foreign LLC. I did this so that if I were to be sued, the court proceedings would be in Wyoming (with very business friendly laws) versus CA where judges out here tend to favor tenants.
@Account Closed Generally, if you are sued, it will be in the state where the property is located or the injury occurred. A Plaintiff generally has the option to sue you in a jurisdiction where the injury occurred, where the defendant resides, or where the defendant is incorporated. Accordingly, if someone gets injured in your Michigan property that is owed by a Wyoming LLC, the injured party is likely going to sue you in Michigan because its easier for them to file a suit there. Unfortunately, the Wyoming LLC cannot help you in that situation.
@Victoria Townsend Your CPA is probably aware of the percentage of people that are using lawyers from out of state to shield themselves from the California tax man.
I am sure many people are simply claiming their LLC does not do business in California. They probably use lawyers as the Registered Agents and they have signatory power.
They will also claim privilege if the tax man comes knocking.
If a judge pushes it, they will simply say they never asked what state you talked to them from and you only have a cell phone.
Of course, this is not done to avoid a mere $800. The lawyer will cost you that much to discuss this setup.
So... it might work for some of your CPA's other clients but it was probably not the best advice for you.
Trust me when I say CA is extremely aggressive. I have had clients who did not listen to me about the CA requirement until it caught up to them 2 years and 3k later in penalties.
Not sure on the CA tax question, but I would always recommend you have an attorney assist with an operating agreement if you are not the 100% owner of the LLC. I make a living because folks who think they are best friends or even family get into business without the deal terms being negotiated and memorialized with attorney help. Shouldn't cost much. Less than a couple thousand and I can guaranty you that a good transaction attorney will prep your agreement with things you should and probably aren't considering right now.
To follow up on the nice post from @Jeff Hall, and while I understand that you’re trying to minimize your expenses so that you can maximize your return, I think it is particularly important to hire a lawyer when you’re forming a multiple owner entity. In addition to making sure that you form the entity properly, the lawyer’s job is to raise issues that may arise in the future between you and your business partners that, had you anticipated them up front, you would have agreed on. This is particularly true given the challenges of co-owner entities and the practical reality that many of them fall apart (and with unintended consequences) because the co-owners couldn't solve arguments months or years into a business. And it doesn't matter how friendly you are with your co-owner. I've seen best friends form businesses that fall apart because of disputes among owners.
Let me give you a hypothetical example of how a good lawyer can protect you. Let's say that you are going to be a 20% owner and that your partner will own the remaining 80%. What protections are you, as the minority holder going to have? Can the 80% owner sell the assets of the LLC without your consent? Can the 80% owner, without your consent, issue more equity and dilute your interests? Can they sell, without your consent, that additional equity to third parties (so that you're in business with not one but two people)? If you had thought about these up front, you would probably want to include provisions in your LLC Agreement that addressed these and other scenarios (a.k.a., minority protections).
Let me give you another hypothetical. Let’s say that you are going into business with a partner and the equity will be split 50/50. Two years later, you and your co-owner can’t agree on anything and your business partnership is failing because you can't agree. Yet you agreed on Legalzoom that neither one of you can transfer your equity without the other’s consent (one of questions that LegalZoom asks). How do you unwind the business amicably and out of court and how do you do so while maximizing the sale price? The answer is that there are many strategies that a good lawyer would be able to help you consider.
This isn’t to say that hiring a lawyer will solve all problems or that these issues would arise if you didn't hire a lawyer. After all, it's much more important to go into business with the right people. However, having addressed these and other potential issues up front, you're giving yourself a better understanding of the potential issues that can arise, you're giving yourself a better chance to succeed (at least I think this is true), and you'll also learn something about your potential business partner in the process of considering these issues and making decisions.
One other thing -- I would suggest that your accountant review your LLC agreement, as well. There are certain things from a tax perspective worth his/her consideration. (This isn't intended to be legal advice -- more my two cents so that you do hire a lawyer and get actual legal advice.)
I hope this helps. Good luck.
"Filing" and LLC and "Forming" an LLC are different. In most states it is very easy to submit the forms to file the entity and be issued a certificate recognizing that the entity has been established. When you hire an attorney to assist you with an entity, this is the easy part and therefore likely represents a tiny fraction of the fees you ultimately pay your attorney. The majority of what you are paying the attorney to do is to Form the entity by not only filing but also drafting the operating agreement and the organizational consents that "kick off" the governance of the entity and establish initial authority.
Most people operate their business through entities to 1.) limit their liability or 2.) get advantageous tax treatment. In order to limit a member's liability the company must be properly FORMED - not just FILED. Properly documenting the company records and operating as a company and not an alter ego of an individual is necessary to defend a lawsuit and protect the individual members from personal liability. A poorly, or improperly, formed entity will not protect the members from personal liability and therefore fails at achieving one of its core purposes.
Also, be mindful of who the attorney forming the LLC represents. The attorney who drafts the operating agreement can represent the LLC but they should not represent the LLC and one or more of the members. It happens, but it is not wise. Each member should have the Operating Agreement examined by their own attorney, who is looking out for their best interests because the interests of the company and the interest of the members are not necessarily the same. Often, individuals forming new companies want to do so as cheaply as possible because the endeavor is a new venture and does not have significant revenue. In such situations they are eager to get the company off the ground and this causes problems down the road when conflict arises between the members.
Always include a push-pull buy-sell in the Agreement or some other mechanism for ending the relationship between the members.
50/50 sounds great and fair, but really doesn't work well.
I'm not in California, but some of my clients are. As I understand it, California is assessing the annual tax on LLCs that were formed in say, Ohio, if they're owned and operated by a California resident. California is apparently taking a very broad view of what "doing business in California" means and using that broad definition to assess these taxes.
I'm of the opinion that if you live in California that owns an Ohio LLC that owns rental real estate, and that rental real estate is managed by a local property management team, you're doing really doing business from California. However, the tax authorities didn't ask me my opinion when crafting this policy, so my opinion doesn't mean a whole lot. What does matter is that the State of California is viewing this scenario a certain way, and when you file your income taxes with the state they'll see the information about the out of state LLCs on the copy of your federal return and figure out this is going on. I think your attorney is correct and your CPA is incorrect.
If you're not acting as the manager then why not just buy the property in your own name instead of using a corporate entity? I usually recommend that my clients have multiple layers of asset protection. The 3 main tools are liability insurance on the property, an umbrella insurance policy, and a corporate entity to firewall business liability off from personal assets. As long as you're using 2 out of 3, you have a lot of protection and peace of mind. Normally I'd advise using the LLC because it's cheap and powerful protection but that's not necessarily true if you're paying $800/year in taxes to California for it. Stop and think about what you're using the LLC for and why you need it and see if perhaps there's a better way to get to where you're trying to go.
I did not read this whole thread (my disclaimer.) If you are in California and California residents own more than 30% of the LLC, you need to register in California. THEY WILL FIND YOU.
Remember, what is good for legal is not always good for tax and vice versa.
In Ohio, unless your business is housed here, you'll need to file a Foreign LLC (or other structure) or else you won't get the protections of Ohio law. In order to file as a foreign LLC, you need one in your home state. Unfortunately, it sounds like you're stuck.