Category: Small Business Law

How to Limit Personal Liability When Starting a Home Based Business

Have you thought of starting a home based business, as a side-hustle or maybe even full-time? Maybe you have a great product idea that you could sell from your home, or a service you can offer. Are you concerned with the potential liability? Limiting liability through business insurance is an option that should be explored, but this article focuses on entity selection.

By failing to form a separate business entity, you are by default operating as a sole-proprietor (individual) or partnership (more than one individual). Depending on the business, it may be a wise choice to form a separate entity for your home based business (such as selling homemade foods).

Sole-proprietor:

Operating as an individual with no separate legal entity.  It is the default classification if you operate as an individual.  A sole-proprietorship is simple to maintain, but offers no liability protection for the owner.

Partnership:

Illinois recognizes several distinct partnerships, but generally a partnership is “the association of two or more persons to carry on as co-owners a business for profit…whether or not the persons intend to form a partnership.” Similar to a sole-proprietor, a partnership may be formed without the partners’ specific intent to form a legal partnership and without any specific filing by the partnership.  That means, if you meet the statutory definition of a partnership, you are a partnership. Partners generally remain personally liable for the debts of the partnership, but are taxed as individuals.

Limited Liability Partnership:

A Limited Liability Partnership (“LLP”) is a recognized form of partnership covered by statute An LLP requires a filing of a statement of qualification with the Illinois Secretary of State.  LLPs, unlike general partnerships, limit the personal liability of partners for the partnership’s obligations.  (805 ILCS 206)

Corporation:

A separate legal entity, defined by statute, and permits different classes of stock and shareholders, and provides liability protection of shareholders.  However, requires more detailed filing requirements.  To form a Corporation in Illinois you must comply with the Illinois Business Corporation Act of 1983 (805 ILCS 5).  The Act requires keeping of corporate records, minutes of proceedings, and other requirements.   For tax treatment purposes, a corporation can elect to be treated as a C Corporation, or as an S Corporation.  A Corporation is subject to double taxation (tax of both the corporate entity and distributions to shareholders). 

An S Corporation is organized like a corporation and provides liability protection to its shareholders. S-Corporations are treated as a pass-through entities for tax purposes. S Corporations are restricted as to the number of shareholders (no more than 100), only one class of stock is permitted, and there are limits on the type of shareholders (must be individuals, with some exceptions).

Limited Liability Company (LLC):

LLCs are governed by the Illinois Limited Liability Company Act (805 ILCS 180).  It is a separate legal entity, and the filing requirements are less complex than Corporations. The current fee for filing Articles of Organization is $150, and the filing of an annual report is $75, which is a one-page form.  The simplicity of an LLC makes it an attractive option for many small-business start-ups. 

Corporations and LLCs need to list a registered agent with a physical address (cannot be a P.O. Box) in Illinois.  The registered agent may be served summons, notice and demands made on the entity.

Many home based businesses may choose to operate as an LLC, which permits limited liability protection of the members, and pass through taxation. Since the filing requirements in Illinois are less complex, and recently reduced filing fees, this is an attractive option.  However, each situation is unique and discussing your options with a business lawyer, may provide additional insight.

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This blog and any materials available at this web site are for informational purposes and not for the purpose of providing legal advice. You should contact an attorney to obtain advice with respect to any particular issue or problem. Use of and access to this Web site or any of the e-mail links contained within the site do not create an attorney-client relationship between the Law Office Of Christian Blume, LLC or Christian Blume and the user or browser.

Must a Limited Liability Company make distributions to its members?

What happens when a member of a Limited Liability Company (LLC) wants an interim distribution, but the other members don’t?  An issue that may arise in a closely held-business formed as an LLC.  LLCs, unlike corporations, are treated as pass-through entities for federal tax purposes, members are taxed based on their interest in the LLC and their proportionate income, whether or not a distribution is made (while it is possible to treat the LLC as a corporation for tax purposes, this is the subject for your CPA or tax adviser to discuss). A member may be allocated income from the company, but may never receive a distribution related to that money.  Some members may not be able to pay taxes on money never received and may demand a distribution. This is one of many issues that may arise in a closely held LLC that can be mitigated in advance with a well drafted operating agreement. 

When forming an LLC with multiple members, a well drafted operating agreement is important for documenting ownership interest and governance of the LLC.  The operating agreement, like many contracts, is used to define the rights and obligations of the parties (members).  Illinois does not require specification as to the ownership interest of each member when filing the Articles of Organization. Further, Illinois does not require that all members be listed, only members with management authority.  

While there are numerous rights and obligations that may be outlined in an operating agreement, this article focuses on rights of distribution, when the company makes a transfer of money, property or other benefit to a member or a party with the member’s ‘distributional interest.’

Default Rule (no Operating Agreement):

The default rule, based on the Limited Liability Company Act (805 ILCS 180), is for distributions to be made in equal shares to the members.  The Act does not provide for mandatory or compelled distributions to members, except when the company is winding up its business.  Many operating agreements may mirror the statutory restrictions on distributions, but may include additional provisions and criteria for distributions. 

Time and Consent for Distribution (in Operating Agreement):

Members may wish to outline the timing and consent for distributions.  The Act does not specify a timing mechanism or voting requirement to make a distribution to members.   An operating agreement can dictate when a distribution is made to the members of the company and may outline the authorization needed for a distribution, including unanimous or majority consent by all members, or only certain members.  The operating agreement can also include requirements for distributions to members when tax liability is incurred. 

Restrictions on ‘Distributional Interest’:

Section 15-5 of the Act restricts what may be altered by an operating agreement, including the restriction of the rights of a person, other than a manager, member, and transferee of a member’s ‘distributional interest.’  Since a ‘distributional interest’ is treated as personal property and may be transferred in whole or in part, a member’s ‘distributional interest’ may be used to satisfy a third-party’s (often a creditor’s) claim against the member, without transferring the other rights held by the member.  Restricting that third-party’s right to a ‘distributional interest’ in the operating agreement violates the Act.     

Additionally, members should be mindful of circumstances when distributions may not be made, regardless of what the operating agreement may state.  A Distribution should not be made, when the LLC would not be able to pay its debts as they become due in the ordinary course of business; or when the assets of the LLC would be less than Liabilities and the amount needed to dissolve.  Individual members may be liable to the LLC for any amount of distribution that exceeds the amount that could have been distributed without violating the prohibitions on distributions.  So even if a distribution is made, but the company is indebted to third-party creditors, the creditors may seek the turnover of those funds from the member.   

When forming an LLC with multiple members, it is important to have a well drafted operating agreement, which may be worth the time and costs of a lawyer to draft and review.  

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This blog and any materials available at this web site are for informational purposes and not for the purpose of providing legal advice. You should contact an attorney to obtain advice with respect to any particular issue or problem. Use of and access to this Web site or any of the e-mail links contained within the site do not create an attorney-client relationship between The Law Office Of Christian Blume, LLC or Christian Blume and the user or browser.

Selling Homemade Food in Illinois: legal considerations.

When I was an Attorney with the City of Chicago, I spent a considerable amount of time doing work at police stations. Some of my fondest memories were made working with Chicago Police Officers. Every so often a retired police officer would make his rounds selling delicious homemade cupcakes.  I will leave his name and company name out of this article, but if you are a south side police officer you may know who I’m talking about. We’ll call him the Cupcake Guy.

The Cupcake Guy would roll into the station with his travel cooler, and the Officers and workers would flock to him to buy an individually packaged cupcake.  These were some of the most moist and delicious cupcakes you could get, and at a very reasonable price.

He likely made these cupcakes in his home.  While not altogether a new concept, homemade goods have been around for much longer than I will even try to determine.  However, the laws that regulate homemade goods, for commercial sale, particularly in Illinois are relatively new, or recently updated.    

There are two statutes this article to focus on relating to home-made food, for commercial use: (1) Home Kitchen Operation (410 ILCS 625/3.6) and (2) Cottage Food Operation (410 ILCS 625/4).

Home Kitchen Operation (410 ILCS 625/3.6)

The Home Kitchen Operation law regulates the production of baked goods in a person’s residence for direct sale to consumers.  Specifically, to fall under the Home Kitchen Operation Statute: (1) monthly gross sales cannot exceed $1,000, (2) the food is a non-potentially hazardous baked good, (3) notice must be given to consumers that the food was produced in a home kitchen, and (4) a label must be affixed to the food package containing the name of the food, and allergen information.  Additionally, the food must be stored in the residence, in which it was produced. In 2018, changes to the statute modified the definition of “baked goods.”   

In order for the law to take effect in your municipality, township, or county, the local government must adopt an ordinance, authorizing home kitchen operations.  

Cottage Food Operation (410 ILCS 625/4):   

Unlike a Home Kitchen Operation, a Cottage Food Operation is not restricted to “baked goods,” but includes all foods other than those specifically banned in the statute, with exceptions.  A Cottage Food Operation permits the sale of home made food to the public, but limits the sale to farmers’ markets, or sold on the farm, where the main agricultural ingredient is grown or delivered directly to the consumer.  

There are several types of foods and ingredients that are banned from being produced by a Cottage Food Operation, unless properly licensed, certified, and compliant to sell these banned foods.  This list includes: meats, certain types of pies (pumpkin, sweet potato, custard, creme), cheese cakes, garlic in oil, and many canned foods.  Additional requirements include: proper labeling, registration with the local government, a food sanitation management certificate, and the placement of a placard with the following notice  “This product was produced in a home kitchen not subject to public health inspection that may also process common food allergens.” Local governments and the Department of Public Health may prescribe further requirements on cottage food operations, so it is important to check with your local municipality.

*Starting a small-business, running a closely held business or facing legal issues in Illinois? Contact Blume Law.

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This blog and any materials available at this web site are for informational purposes and not for the purpose of providing legal advice. You should contact an attorney to obtain advice with respect to any particular issue or problem. Use of and access to this Web site or any of the e-mail links contained within the site do not create an attorney-client relationship between the Law Office Of Christian Blume, LLC and the user or browser.