Taking over a dormant LLC

May 21, 2008: 10:58 AM ET

Forming your own new entity is a better idea, the experts say.

Dear FSB: I am looking to form an LLC on a new business with a group of partners. The S-Corp. is less expensive and less complicated and has deductions on personal taxes, but I was informed that an S-Corp must have all the corporate officers drawing a salary - and this is not applicable for a startup company. So, I recently found a colleague that has a dormant LLC that has never been used (he formed it and let it sit dormant because his business partners split up.) I am considering buying it for a greatly reduced price so he could recoup some of his costs, but wonder whether there are potential liabilities to be concerned about - even for a dormant NYC LLC. Am I correct in assuming that there could be potential hazards and liabilities involved - even if my colleague (who owns the dormant LLC) assures me it's been sitting idle since inception?

By Lenora Chu, Fortune Small Business contributor
Dear Thomas: On the whole, the experts recommend forming a new LLC rather than acquiring a dormant one.

Why? For starters, it's possible that even an inactive LLC might have incurred tax or other liabilities that are unknown, despite the assurances of your colleague.

"My reluctance would increase with the amount of time the LLC has been dormant," says attorney and partner Edward T. Savage of the international law firm Reed Smith, LLP.

For example, some states impose a type of franchise tax payable on an annual basis simply to keep an entity in good standing with the state, according to Washington, D.C.-based attorney Bob Reif of Epstein, Becker & Green.

If the LLC in question did not pay these fees, the state could revoke its charter, in which case there would be costs to "re-start" the LLC, Reif says.

Realize also that any cost savings you anticipate by acquiring a dormant LLC - rather than forming a new one - may be immaterial, Savage says.

The "publication costs" associated with forming an LLC can be as little as $225 in some counties, or as much as $2,000 in New York State.

Even if your colleague gives you the dormant LLC free of charge, the amount you might save by taking this route is at most the publication cost.

"I would question whether such savings justify the potential risks of liabilities that might be inherited," Savage says.

Savage adds that he generally favors the use of S-Corporations over LLCs because S-Corporations are less complicated and are subject to a well-established framework.

The legal fees needed to prepare a limited liability company agreement for the LLC may also be substantial, and you're also more likely to incur additional legal costs when new investors join.

Consider using an LLC in those circumstances where you'll need a tiered capitalization structure, or varying types of equity to provide different measures of return to investors, Savage says. Indeed, as Reif says, an LLC is often more flexible than an S-Corporation because the principals have greater opportunity to address unique economic arrangements for sharing profits and losses.

Furthermore, other entities, such as corporations, can also be owners of the LLC, yet with a few exceptions only individuals can be owners of the stock of an S-Corporation.

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How to switch an S-Corp to an LLC

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