An LLC provides limited liability protection and pass-through taxation, shielding owners from business debts while simplifying tax obligations. Forming an LLC requires choosing a state, selecting a name, appointing a registered agent, and filing necessary documents.
By Brad Nakase, Attorney
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Businesses can enjoy the benefits of pass-through taxes and limited liability protection by forming an LLC. When a company has limited liability, its investors may only lose as much as they put into the company. Members of an LLC are normally shielded from individual responsibility for business debts and responsibilities due to the LLC’s distinct legal status.
Because an LLC is subject to pass-through taxation, its profits are not subject to taxes on an entity level. The owner(s) instead get a share of the LLC’s profit or loss as reported on the return. The owners, also known as members, are then obligated to disclose the profit or loss on their individual tax returns and make any required tax payments.
An LLC might be considered a “disregarded entity” if it has just one owner. In this case, just the business owner is required to submit a tax return, not the LLC.
For limited liability companies (LLCs) with multiple owners, it is necessary to file both an individual tax return and an information return for the company.
You may get several benefits by registering your firm as an LLC. Below, we will examine a few of the most significant benefits.
1. Limited Liability
An LLC is similar to a corporation in this regard. Forming an LLC protects shareholders from personal responsibility and debt incurred by the firm.
Consider Joey’s shoe store, “Bless My Sole,” which is losing business to a more posh establishment around the block. The company has gone eight months without paying rent or for three shipments of shoes because business is bad. As a result, the creditors who have sued “Bless My Sole” are demanding payment of almost $75,000.
While Jimmy’s creditors can seize his business debts, they have no legal claim to his personal assets, such as savings accounts, gold, or property. To pay off debts, an LLC can only sell its assets, not the personal possessions of its owners. This is a significant benefit that is lacking in other business structures, such as partnerships or sole proprietorships, which expose owners’ personal assets to more legal risk.
2. Taxation
The IRS does not treat the business as a distinct tax entity, hence it does not impose taxes on the business directly. Rather, members are responsible for paying the taxes through their individual income taxes. Take a look at this example.
Imagine for a second that “Bless My Sole” is a two-person operation that generates $60,000 in annual net profit. Each member’s individual tax responsibility will be based on their share of the net earnings, which will be split by the number of members. Tax returns must be prepared in the same way as those for corporations, partnerships, or sole proprietorships because LLCs are not recognized as separate legal entities for this reason.
Be aware that the Internal Revenue Service (IRS) treats some limited liability companies (LLCs) as corporations for tax reasons. If an LLC is not already a corporation, it can choose to be one by submitting Form 8832. Changing the LLC’s categorization status requires the use of the same form.
3. Less Worry
There are fewer steps, paperwork, and expenses involved in forming an LLC than with any other type of company. There are less record-keeping and regulatory concerns with this business structure, which makes operations much easier. Because an LLC is not required to have a formal board of directors, have regular meetings, or keep meticulous records, its managers have a great deal of leeway. These features make things easier and save a lot of work.
It is common practice to file the “articles of organization” when forming a limited liability company (LLC). This document contains the company’s name, address, and members’ details. In the majority of states, you’ll need to pay a fee to file with the Secretary of State.
The next step is to draft an operating agreement, which is essential for multi-member limited liability companies (LLCs) but not required in most states. Obtaining additional licenses and permissions is a necessary step in registering a business.
Also, you’ll need to place an ad in the local paper to announce the establishment of an LLC in some states like Arizona and New York.
4. Allocation Flexibility
There is a lot of leeway in investment and profit distribution with an LLC.
An individual who owns 25% of the limited liability company (LLC) does not have to put up capital in the same proportion as their ownership stake since members have the option to invest in a different proportion than their ownership percentage. To do this, one can draft an operating agreement that specifies, in terms of percentages, how each member, irrespective of their initial investment amounts, would share in the profits (or losses) of the business. Investors from outside the company need not really possess a stake in it in order to contribute money into it.
Members of an LLC also have a bit of flexibility in deciding how to divide up the company’s earnings. Ownership and the distribution of earnings are not always synonymous. To reward someone for the additional time or effort they’ve put into running the company, the group may decide to give them a larger share of the earnings.
If you’re still on the fence about forming an LLC, there are a few things you should know. (However, the benefits often exceed the negatives.)
Even though there are fewer administrative and regulatory requirements to establish an LLC than a corporation, the process is still not without its challenges. These are the standard procedures for forming an LLC, but specifics may differ from state to state.
Step 1: Pick a state
The first thing you need to do when forming an LLC is pick a state. You can establish an LLC in whatever state you wish, regardless of whether or not the LLC intends to conduct business in that particular state.
Having said that, the majority of limited liability company owners opt to establish their entity in the state where they want to conduct business, which is frequently their home state. One explanation is that the creation and administrative expenses of an LLC might rise if it is established in a state other than the one where it will conduct business. This is because the LLC will then need to register as a foreign LLC, also known as foreign qualified, in order to do business in the state where it will be engaged in operations.
Some states are better than others for particular types of small company owners due to differences in formation costs, yearly report fees, taxes, and LLC regulations.
Step 2: Give your LLC a name
Before you can make an LLC, you need to come up with a unique company name. Specifically, the name cannot be identical to another qualifying LLC’s or other business entity’s record with the Secretary of State. You should know this because a lot of sole owners who already use a registered trade name or “doing business as” (DBA) name may want to use that DBA name as their formal company name when they become an LLC.
In order to ensure that the name you have in mind for your limited liability company (LLC), including any names you may have registered as your DBA, is available, you should look for the name on the website of your formation state. Keeping the name reserved is a smart move if you aren’t quite ready to submit the paperwork to register your limited liability company. Many jurisdictions provide the option to temporarily reserve a company name for a nominal cost.
To be sure no one else is using your intended name, it’s smart to look it up in trademark databases.
Step 3: Select a registered agent
Having a registered agent in the state of formation is necessary when creating an LLC or when setting up an existing company to do business in a different state.
A state-registered business’s agent for service of process, or registered agent, is responsible for receiving critical legal papers and tax forms on the company’s behalf. Included in this category are official communications from the state’s tax department and the Secretary of State (including yearly reports and announcements) as well as other essential legal papers.
Service of process, also known as a Notice of Litigation, is a legal document that must be received by a registered agent. A complaint and summons are the usual legal documents that serve as notification that an action has been taken against an LLC. The registered agent also receives subpoenas and orders to garnish wages, among other court paperwork.
The registered agent of an LLC need not be the owner of the LLC; yet, there are many good reasons why entrepreneurs pick a third party to handle this crucial task. Serious issues might arise for the LLC, among other reasons, if the registered agent is unavailable or the recipient mishandles time-sensitive papers. Additionally, the registered agent can’t utilize a post office box; they need a real location within the state.
Step 4: Draft an operating agreement for your LLC
Almost all states need an operating agreement for an LLC. Even if verbal agreements are legal in the majority of jurisdictions, a formal operating agreement is still required for every limited liability company. A limited liability company (LLC) operating agreement is, as the name suggests, a document outlining the rules and regulations that the members and the company will follow.
A single-member limited liability company (LLC) nevertheless requires an operating agreement even though it has just one owner. This demonstrates your recognition of the LLC’s legal autonomy and will help in avoiding “piercing the veil” situations. Additionally, it provides an opportunity to document your wishes for the handling of certain matters, such as your incapacity to run the firm, and permits you to bypass specific standards of the LLC laws that you may not want to apply to the LLC.
A well-crafted operating agreement is especially critical for multi-member limited liability companies. The document will outline the division of work, ownership, and earnings in a clear and concise manner, which helps to prevent disagreements among the owners.
Not only that, it should spell out the chain of command, the minimum number of votes needed to approve specific transactions, the process for adding or transferring members, the allocation of losses and profits, the means of transferring membership interests, and more. Your attorney should go over the operating agreement to make sure everything is in perfect shape.
Step 5: Send the Secretary of State your LLC’s Articles of Organization
Legally establishing a limited liability company (LLC) requires completing the necessary paperwork with the state’s office that processes business filings, often the Secretary of State’s office. You could hear this document called a Certificate of Organization, Articles of Organization, or Certificate of Formation. Different states have different filing costs.
Can a limited liability company be “incorporated”?
The proper way to talk about the formation of a limited liability company (or any other type of entity, excluding a corporation) is to say that the company has been “organized” or “formed”. The terms “Articles of Incorporation” and “incorporation” are applicable to corporations, regardless of their tax status (C or S).
How are the Articles of Organization for an LLC Drafted?
The specifics of the LLC creation paperwork required by each state may vary, however there are a number of things that all states’ forms share:
An LLC’s Articles of Organization can be found on the state’s official website; they must be signed by the individual who created the LLC, who need not be an owner or manager in most cases; and in certain states, the consent of the registered agent to serve as registered agent is also necessary.
Upon filing and approval, the state will provide a certificate or other verification document that proves the LLC’s existence and may be utilized for many purposes such as opening a company bank account, getting an EIN, etc.
An additional note about the publishing requirement for limited liability companies (LLCs): in certain states, it is also necessary to publish a notice, usually in a local newspaper, certifying the creation of the LLC. After that, you may be required to submit a publication certificate with the state.
Step 6: Submit a report detailing beneficial ownership
If your limited liability company is not exempt, it is required by law to submit a beneficial ownership information (BOI) report with the U.S. Department of Treasury’s Financial Crimes Enforcement Network (FinCEN). This report details the persons or entities who control or own the company, and it also requests data about the company applicant (the person who files the paperwork to form or register the LLC).
Step 7: Get licenses, an EIN, and a sales tax ID
The next step after forming an LLC is to apply for an employer identification number (EIN) with the Internal Revenue Service. This number will serve as the tax identifier for any bank accounts, income tax returns, and employment tax filings pertaining to your LLC.
Also, you’ll have to fill out an application for a sales tax ID with the state’s tax department, and in every state where the LLC will be conducting business, you might have to register with the labor department as well. Your company might have to get a license or permit for each jurisdiction as well.
Step 8: Open a bank account for your business
A business credit card can help keep personal and business transactions separate and can also help build business credit. It is essential to separate company funds from personal ones. Courts consider creating a business bank account as a good idea for anyone who has established an LLC because it is one of the primary elements in deciding whether to pierce an LLC’s veil and hold the owner responsible for the LLC’s debts.
To create a business account, you will need to provide the following facts to most banks: the date of creation, the kind of business, the addresses and names of the owners, and the EIN.
Step 9: If required, register your business to do business in additional states
To be “foreign qualified” in every state where your limited liability company (LLC) will be conducting business, you must first register in the formation state and then in each extra state. (“Foreign” means any jurisdiction or state other than your state of formation.) To be “foreign qualified” in a state typically means to fill out a Secretary of State application, along with a Certificate of Good Standing and the appointment and maintenance of a registered agent by the LLC.
In order to foreign qualify, a company must meet a number of guidelines. Some of the most common ones are:
It is important to consult an attorney if you are unsure as to whether your limited liability company (LLC) must foreign qualify in a certain state, as the requirements vary by state.
1. Who can set up an LLC?
Although most states don’t have residency or legal limits on who can start an LLC, some states do require its owners and/or managers be at least eighteen years old, or the age of consent.
2. Can I form an LLC without hiring a lawyer?
You can save money on attorney fees by forming your limited liability company (LLC) on your own. One of the most critical forms required by an LLC is the Articles of Organization, which you can prepare and file without the help of a lawyer. Just make sure you know what your intended state of incorporation requires.
3. How do I decide on a name for my limited liability company?
When forming a limited liability company (LLC), it is wise to choose a name that reflects the values you want to uphold for the business. It’s also helpful if the name is simple enough for customers to spell and remember. When choosing a name, keep in mind that it must not be confusingly close to any existing business in the state where you are incorporating. In addition, most states require that the name you choose include the words “Limited Liability Company” or the short form “LLC.”
4. When forming an LLC, what is the minimum number of members required?
A limited liability company (LLC) may enjoy an unlimited number of members (owners), and the Internal Revenue Service (IRS) recognizes one-member LLCs as being eligible for pass-through tax status; however, state taxation laws may have different requirements.
5. What kind of taxes do you pay on an LLC?
In general, limited liability companies (LLCs) that have at least two owners are taxed similarly to partnerships, while those with just one owner are treated more like sole proprietorships. Unlike partnerships, which are required to submit an informational tax return, LLCs with one owner are not. In either case, the owners’ personal tax returns will show how much they made or lost from the company, and any taxes owed will be paid by the owners themselves at the personal level.
Profits and losses from limited liability companies (LLCs) are subject to corporate income tax or, depending on the state, state income tax that is similar to or identical to that of the Internal Revenue Service (IRS).
LLCs must also pay any franchise taxes levied by the state where they were formed. These taxes are collected just because an LLC is registered or formed to do business in that state; the exact amount varies from state to state, but in general, they are due every year. For example, in California, LLCs must pay a minimum of $800 in franchise taxes.
6. What does the setup of an LLC look like?
The owners of a limited liability company (LLC) are its members, who are like shareholders in a corporation or partners in a partnership, depending on the management style of the LLC. If the LLC uses managers, the members are more like shareholders because they aren’t involved in running the business, but if the LLC doesn’t use managers, the members are more like partners because they have an important say in how the company makes decisions.
7. How do you run an LLC?
The members (owners) of an LLC can run the show in a manner similar to a partnership, with each member having an equal vote in major business decisions. On the other hand, the members can choose a manager or managers to serve in a role analogous to a board of directors in a corporation, and these managers are responsible for running the day-to-day operations of the company.
State law often establishes member-management as the default arrangement. This implies that members will have the power to govern the activities of the LLC in the absence of a manager being designated in the Articles of Organization forms.
8. What is the publication requirement for an LLC?
Some states have a publication requirement for new LLCs. In the state of New York, LLCs must issue a notice of their creation or registration in two local papers and file publication proof with the Department of State within a period of one hundred and twenty days. If a company does not fulfill the publication requirement in time, the company’s ability to conduct business in the state of New York will be suspended.
9. Can I form an LLC without a registered agent?
Appointing a registered agent is a necessary step when forming an LLC or registering to do business in another state (a procedure known as foreign qualifying).
10. When forming an LLC, what are the first steps?
The first step in forming an LLC is to decide on a legal structure. Once your LLC paperwork is filed, the next step is to call a company meeting of the members and managers. At this meeting, you can establish the LLC’s operational agreement, distribute membership interest certificates, and take care of other groundwork matters, like approving the creation of a bank account.
11. What is an LLC with only one member?
Although it still offers asset protection, a single-member LLC is considered a “disregarded entity” for federal tax reasons. You will still need to use Schedule C to record the business’s taxable revenue and costs, and then you may transfer that data to your personal Form 1040.
12. What does an LLC operating agreement do?
The members of the limited liability company (LLC) write the operating agreement at their first meeting. The operating agreement is a contract that defines the parameters and specifics of the LLC.
13. What is a Professional Limited Liability Company (PLLC)?
If you work in an industry that requires a license from the state, you can set up a professional limited liability company (PLLC) to offer your services.
14. How can an LLC receive an Employer Identification Number (EIN)?
Businesses may apply for an EIN (Federal Tax ID number) by completing and submitting an IRS Form SS-4.
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