Is an LLC the right entity for your business?
Learning how to form an LLC is quite an easy task with the proper guidance. A limited liability company, or LLC, combines the benefits of sole proprietorship and partnerships. Additionally, there are great tax benefits.
LLCs also offer limited liability protection that is often superior to protections for corporations because it is more difficult to “pierce the corporate veil” and attach personal property to an LLC. An LLC is not considered to be a corporation. Instead, it is considered to be an unincorporated business entity.
In order for you to learn how to form an LLC, you typically must follow a uniform process. Usually, forming an LLC requires a state filing in the Secretary of State’s Office. That being said, many states allow you to complete the process online. Individuals can form LLCs and the number of members permitted varies due to local state laws. What is required for the state filing consists of the following information:
All LLCs are required to have at least one member. LLC members are typically owners of the LLC just like shareholders are the owners of a corporation or the partners of a partnership. Similar to shareholders, a member’s liability to repay the LLC’s obligations are limited to his or her capital contribution.
Members may be natural persons, corporations, partnerships, or other LLCs.
A member’s ownership in the LLC is called the “membership interest.” Membership interests are typically divided into standardized units, which are often called shares. Unless otherwise mentioned in the operating agreement, a member’s right to control to manage the LLC is proportionate to their membership interest.
LLCs are normally managed by their members in proportion to their membership interest. That being said, many operating agreements provide for a manager or board of managers to run the day-to-day operations of the LLC. The managers are elected or appointed by members and may also be removed by members. A member may be a manager or managing member, which is similar to the managing partner of a partnership.
Articles of Organization
All LLCs must file evidence of their existence with the Secretary of State of the state where they choose to be incorporated. The Articles of Organization serve this purpose and are the LLC version of a corporation’s Articles of Organization serve this purpose and are the LLC version of a corporation’s Articles of Incorporation.
All LLCs must disclose their company name, appoint a statutory agent, and disclose their purpose of business. Additionally, the fees for filing the Articles of Organization also vary by state.
The Operating Agreement of an LLC is the most important document because it determines, defines, and allocates the rights of the members. Operating Agreements must be drafted carefully in order to avoid common disputes that transpire between members.
If an LLC decides to be taxed as an S corporation, the LLC can bypass double taxation by reporting its entire income on the personal income tax returns of its members. This calculation is conducted based on the varying percentage of interest that the owners have in the business. The Operating Agreement will dictate how this is apportioned. That being said, choosing to be taxed as an S corporation evades double taxation, it also means that company losses can be reported on the shareholders’ personal income tax return, which reduces tax liability.
LLCs provide limited liability protection to their members. Members are normally not personally responsible for the business debts and liabilities of the LLC. Creditors can’t go after your personal assets of members to pay business debts.
LLCs have a flexible management structure. LLCs can be managed by the members or by managers, unlike corporations which have a board of directors who control major business decisions.
Forming an LLC might help your business gain credibility, especially early on. An LLC shows customers, employees, and vendors that you have made a formal commitment to your business.
LLCs faceless state-imposed annual requirements than S and C corporations.
The IRS doesn’t impose taxes on the LLC. LLC income is reported on the member’s (business owner’s) individual tax returns. Unless your LLC is taxed as a corporation, you will be taxed as a self-employed person. What that means is that the profits won’t be taxed at the corporate level, they will pass through to the members of the LLC. The members will have to pay tax on the profits on their personal federal tax returns. Many times, the taxes will be higher this way than they would be at the corporate level. Before you form your LLC it is important to speak with a tax professional.
For example, in California, currently, you must pay $800 annual LLC tax to FTB (California’s Tax Board). If your business makes over $250,000 per year, you may be required an additional fee with your annual tax return.
An LLC costs more to establish than a sole proprietorship. Many states also impose ongoing fees.
Selling a corporation is simpler than selling an LLC.
LLCs are newer entities than corporations. You will find fewer qualified professionals to help you with your LLC. It is always best to seek the professional advice of an attorney and a CPA to determine which is the best entity for your business.
Do I need a lawyer to form an LLC?
You can start your LLC by using a service like Nolo. They have a good system to walk you through the process and answer your questions. Of course, it also helps to speak with a business attorney before your form the LLC.
How many people do I need to start an LLC?
You can start an LLC with only one person in your company.
How much does it cost to set up an LLC?
Each state charges a filing fee for registering an LLC. I recommend that you either hire an attorney if you can afford one. If you have a smaller budget to work with, you can use services like Nolo to form your LLC.
I also recommend that you read this article on how to form an LLC published by Fit Small Business.
photo credit: Startup Live Lisbon