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Carl Kanowsky: Contractors can now be LLCs

It's The Law

Posted: December 2, 2010 8:21 p.m.
Updated: December 3, 2010 4:55 a.m.
 

Politicians sometimes make decisions that make sense to no one.  I know this comes as a shock to many of you. But think of some of the more famous boondoggles of the past. Like the Alaska Bridge to Nowhere or the Army’s $900 hammer.

Back in the 1990s, when our esteemed political leaders decided to join the rest of the nation and allow for the creation of limited liability companies (LLCs for short), for some unfathomable reason they said that general contractors could not form an LLC.

Their rationale — if contractors could be LLCs, then they would have the liability protection of the LLC to guard them against lawsuits based on their negligence.

The problem with that argument — contractors have long been able to practice in the form of corporations, thus already being afforded that liability protection the people in Sacramento were so concerned about.

Despite this reality, our esteemed leaders decided to exclude contractors from forming LLCs. And that has been the law of the land since 1994.

Apparently, contractors as a group got so tired of being excluded that they beseeched the California Legislature to change the law. Our own state Sen. George Runner, R-Antelope Valley, introduced a bill in 2002 to accomplish this goal.

Unfortunately, that bill died in committee without even being heard. 

There were several subsequent attempts. Most notably in 2008, state Sen. Lou Correa, D-Santa Ana, wrote a bill that got past one committee only to fail in the Judiciary Committee.

Correa’s bill would have removed the contractor exclusion from the LLC law, allowing for contractors to form an LLC in much the same manner in which they currently form corporations for their practice. But apparently a fear of contractors running wild with their liability shields, which would prevent their customers from suing contractors personally if they caused any damage, caused the bill to die.

Then in 2009, state Sen. Dean Florez, D-Shafter, (together with the Associated General Contractors of California) figured out a way to get beyond this roadblock.

To appease these liability concerns, Florez introduced a bill that would allow contractors to practice as an LLC so long as the contractor either purchased a $1 million liability insurance policy, or put aside $500,000 in a blocked bank account to be used to pay for any liabilities. This provision mollified concerns.

The bill passed the legislature and was signed by the governor on Sept. 30. The bill takes effect in 2011, but in yet another unexplained twist, the Contractors State License Board does not have to start issuing licenses to LLCs until 2012. Ah, politicians, don’t you just love ’em?

For customers of contractors, the permission to practice as an LLC likely will not have much impact. As mentioned before, contractors already, practice in corporate form so this does not add any new elements of protection for unscrupulous contractors.

As for contractors, for the price of a $1 million policy, they can now do business with an entity form that is much easier to use than corporations. LLCs are pass-through entities, just like S corporations.

That is, for federal tax purposes, the entity is ignored, and the profits (and taxes based on them) flow through to the owners of the LLC. But unlike S corporations, owners of an LLC can include corporations or other LLCs.

Profits and losses can be distributed in a more realistic fashion to reward those who are the most responsible for the success of the company. And the operation of an LLC is much more relaxed. 

There are no requirements to hold annual shareholders or directors meetings.  Things are more informal, allowing for more flexibility in the operation of the business.

Overall, this is an excellent development for contractors even with the $1 million policy requirement. 

So, watch for your local plumber doing business as an LLC in the future.

Carl Kanowsky of Kanowsky & Associates is an attorney in the Santa Clarita Valley. He may be reached by e-mail at cjk@kanowskylaw.com.  Mr. Kanowsky’s column represents his own views, and not necessarily those of The Signal. It’s The Law appears Fridays and rotates between members of the Santa Clarita Valley Bar Association. www.SCVbar.org.  Nothing contained herein shall be or is intended to be construed as providing legal advice.

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