An LLC offers liability protection, flexible management, and pass-through taxation for many small business owners. Review LLC formation steps, benefits, drawbacks, taxes, and registered agent requirements.
By Brad Nakase, Attorney
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Many small company owners use limited liability companies (LLCs) as their preferred business form. It offers managerial freedom, pass-through taxation, and limited liability protection. Examining the advantages and restrictions of an LLC, how to form one, & other important LLC-related subjects is important. It can help you determine if an LLC is the best option for you.
A limited liability company (LLC) has the best of both worlds. The management flexibility of a partnership and the limited liability and separate legal existence of a corporation. It retains pass-through taxes. A situation where the debts and possible losses of a company are limited to the amount of money invested in that company is called limited liability.
Owners are usually not held personally liable for the debts and liabilities of the LLC. The LLC is a distinct legal entity from its owners. To put it another way, their private assets are typically kept safe.
The LLC is regarded by the IRS as a pass-through entity. In other words, company earnings are not subject to business entity-level taxation. Rather, any profit or loss recorded on the LLC’s return is “passed on” to the owners. The owners, referred to as “members,” are then required to pay any applicable taxes and record the loss or income on their individual tax returns.
The LLC may be viewed as a “disregarded entity” if it only has one owner. In this case, only the business owner’s tax return needs to be filed, not the LLC’s. An informational tax return for the LLC should be filed in addition to the personal tax returns of the company’s owners if the LLC has many owners. In this case, the LLC is usually handled as a partnership. LLCs have the option to choose between C & S corporation taxation.
The LLC’s owners (members) have the option of managing the company themselves or designating managers to handle day-to-day operations. Managers may be a mix of owners & appointed managers or just appointed managers.
Benefits and drawbacks of an LLC
Many first-time entrepreneurs wonder what an LLC is and how it works before starting a business.
Knowing what an LLC offers in terms of defense from liability, taxation, management system, and compliance obligations is helpful when deciding whether to create one. Remember that the benefits or drawbacks of an LLC may vary based on your company’s priorities.
Any claimed drawbacks are often outweighed by the advantages of forming an LLC. These are the primary explanations for why modest business owners frequently decide to form an LLC.
1. Individual asset protection: Owners of LLCs are protected from being held personally liable for decisions made by the LLC & its other members. The proprietors’ personal assets (home, savings accounts, etc.) cannot be used by creditors to settle corporate obligations. There is no legal separation between the owners and the business in a general partnership or sole proprietorship. In the absence of this separation, the owners’ personal assets may be targeted by creditors or other parties to pay off the company’s debts. It should be noted that an LLC might forfeit its limited liability. “Piercing the veil” is the term for this.
2. Flexible ownership: There is no cap on the number of LLC members, who can be companies, partnerships, trusts, or individuals. The list of shareholders in S corporations, another common choice for small firms, is somewhat more limited. Additionally, the number of stockholders in an S corporation is limited.
3. Flexible management framework: LLC members have the option of choosing a management group or managing the LLC themselves. The owners are in charge of day-to-day business operations when an LLC is “member-managed.” The LLC is similar to a corporation when it is run by appointed executives (a “manager-managed” operations structure), in which the directors & officers, not the shareholders, are in charge of business management.
4. Adjustable taxation: LLCs normally do not have to pay business entity taxes. Owners declare any business profits or losses on their own personal tax returns, which are “passed-through” to them. Every tax that is owed is paid on an individual basis. In other words, because the LLC is not subject to both entity and individual taxation, it avoids double taxation.
Businesses that are not eligible for S corporation taxation are taxed at the corporate level, and their shareholders pay taxes on the income they receive. (Because it is taxed according to IRS Subchapter C of the Internal Revenue Code, this sort of organization—which is the standard when you incorporate—is referred to as a C corporation.)
5. Increased credibility: Since an LLC is a more formal corporate structure, unlike a sole proprietorship or partnership, it may aid a new company in building credibility. An official registration with the state creates an LLC. A state filing is not necessary for sole proprietorships & general partnerships to exist. You ought to know what an LLC is and how it works.
6. Restricted compliance requirements: LLCs are subject to fewer state-imposed requirements for compliance. There is less ongoing formality compared to corporations (C corporations or S corporations).
Selecting an LLC as the company form is said to have a number of drawbacks. (The benefits frequently exceed the disadvantages.)
1. Cost: An LLC often has higher startup and operating costs compared to a general partnership or sole proprietorship. States impose an upfront formation fee. Additionally, a lot of states charge recurring costs like franchise taxes and/or annual reports.
2. Additional compliance requirements: The majority of firms have compliance requirements, such as getting a company license and reporting new staff members to the state.
Additionally, an LLC has continuous compliance requirements with the state, just like an S or C corporation. Keeping a registered agent & submitting an annual report are two examples.
3. Limited transferability of ownership: Compared to a corporation, the ownership of a limited liability company is often more difficult to transfer. Unless there’s a shareholder contract to the contrary, corporations may sell their stock to increase ownership, and shareholders may sell their shares to third parties. One of the explanations for why investors favor C corporations is the unrestricted flexibility to purchase or sell equity in the form of stocks.
LLCs usually require the consent of all members in order to add new members or change the ownership proportions of current members, except when the members agree differently.
LLCs are typically simpler to establish than corporations. There are still certain administrative and legal requirements. These are the fundamental procedures for creating an LLC. State regulations may differ.
Many freelancers ask what an LLC is and how it works before formalizing their business.
Step 1: Select your LLC’s creation state
Even when the LLC won’t be conducting business there, you are free to form one in any state. Nonetheless, the majority of LLC owners decide to establish an LLC within the state in which they want to conduct business, which tends to be their home state.
Important: You must register a limited liability company in the two states if you create it in one state but conduct business in another. You would register as a foreign LLC in the second state. This entails handling two states’ worth of state filings, costs, and compliance obligations.
States differ greatly in terms of formation fees, yearly report fees, taxes, and LLC legislation; therefore, some states are better for some small business proprietors than others.
The state in which they reside and run their company is the ideal place to establish an LLC for the majority of small business owners. This reduces expenses and complexity by reducing the need for dual registration. Some states offer advantageous tax implications or legal protections. Delaware, Nevada, & Wyoming are well-liked for particular business circumstances.
Step 2: Name your LLC
The guidelines for naming an LLC vary by state.
LLC designation: LLC name must conclude with a phrase or acronym that has been allowed by the state to identify the company as a limited liability company. Example: “LLC” or “Limited Liability Company.”
You should do a name search on the website of your Secretary of State to see if your preferred LLC business name has already been in use. You may hold the name for a modest cost, usually for 60-120 days, if you’re not prepared to submit your LLC formation paperwork. It’s also a good idea to perform a USPTO trademark search.
Step 3: Select a registered agent
A registered agent within the state of creation is required when establishing a new LLC. You will also require a registered agent in the state if you subsequently form your LLC to conduct business there (foreign qualification).
Important legal & tax documents are received on behalf of your LLC by a registered agent, also referred to as an agent for service of process. These records may consist of:
A registered agent’s main function is to guarantee that your LLC receives process service. States mandate that all LLCs keep one for this reason.
There are several strong reasons why owners of businesses will select an authorized agent service company to help with this essential need, even if the owner of an LLC may decide to act as the LLC’s registered agent. Serious issues for the LLC may arise, among others, when the registered agent is unavailable when urgent documents are delivered or if the recipient treats them improperly. When it comes to process service, incorrect handling can result in the expensive risk of an automatic ruling against the LLC. Additionally, the registered agent is unable to utilize a PO Box and must have a real address within the state.
Step 4: Establish the management structure of the LLC
“Member managed” & “manager managed” are the two management options available to LLCs. All LLC owners (members) take part in managing the company under a member-managed LLC. Managers selected by the LLC’s owners oversee the LLC under a manager-managed LLC. A common question among new entrepreneurs is what an LLC is and how it works in daily operations.
When submitting the formation documents, certain states mandate that you specify the LLC’s management structure.
Step 5: Create an operating agreement for your LLC
Almost all states require an LLC operating agreement. It is strongly advised that each LLC have a documented operating agreement, even if the majority of states permit oral agreements. This document, as its name suggests, is an agreement between the LLC & its members (owners) regarding the way the LLC will be run. An operational agreement is vital even if there is just one owner (as in the case of a single-member LLC).
This can help prevent penetrating the veil & demonstrates your respect for the LLC’s independent existence. You can also express in writing what ought to happen in specific situations, like when you are unable to run the company. Additionally, it enables you to opt out of or override specific default elements of the state’s LLC law that may not be appropriate for your company’s purposes.
A well-written operating agreement is particularly essential for LLCs with multiple members. This contract often hinders disagreements among the owners. It explicitly outlines the division of labor, profits, and ownership. It should specify, among others:
It is advised that your attorney evaluate the operating agreement to ensure that everything is covered.
Step 6: Send the state your articles of organization
You must submit LLC formation paperwork to the Secretary of State’s office (or the department in charge of business registrations in the formation state) in order for your new LLC to be formally recognized. The terms Certificate of Organization, Articles of Organization, and Certificate of Formation are often employed to describe this document. The U.S. has varying filing fees.
State-specific LLC formation documents differ, although the majority call for:
Each state typically provides standard forms for an LLC’s articles of organization. The document must be signed by the LLC applicant. Usually, the individual does not need to be a manager or a member (owner). In certain states, the registered agent’s approval to act as the LLC’s registered agent must also be included. The state will provide a certificate or similar confirmation document after it has been approved and submitted. The certificate can be utilized to open a bank account for the business, get an EIN, and more. It also acts as official documentation of the LLC’s status.
An LLC is not a corporation, despite the fact that it is often said to be “incorporated.” The terms “incorporation” and “articles of incorporation” are intended to refer to a corporation (irrespective of whether it is subject to taxation as a C corporation or an S corporation), so the proper way to describe the formation of an LLC (or any other type apart from a corporation) is to imply that the business was “organized” or “formed.”
Nonetheless, it is often known that “to incorporate an LLC” refers to creating an LLC.
Additionally, some states mandate that you post a notice verifying the establishment or registration of the company entity, usually in a local newspaper. You might have to submit a certificate of publication to the state after posting the notice. States with publication requirements for LLCs are Nebraska, Arizona, and New York.
Step 7: Get licenses, an EIN, and a sales tax ID
You should apply for an EIN (employer identification number) with the IRS after creating the business organization. Your LLC will utilize this identification number for all of its bank accounts as well as for submitting income and employment taxes.
You may additionally be required to sign with other departments and agencies of the government. Here is an example of what would be needed.
The state law, the local government, and the sector you work in will all have different requirements.
Step 8: Create a bank account for your business
For any firm, establishing an official bank account is a standard and recommended procedure. It is necessary for an LLC to keep personal and corporate finances apart. When determining whether to penetrate an LLC’s veil & hold an owner accountable for the LLC’s debts, courts take this into account. In addition to helping establish corporate credit, a credit card for businesses can be utilized to keep both professional and personal activities apart.
To establish a business account, the majority of banks require information about the firm, including the date of creation, the type of business, the names and addresses of the owners, and the EIN.
Step 9: If required, register to conduct business in additional states
You must register your LLC in each state if it intends to conduct business there. This procedure is called “foreign qualification” (where “foreign” refers to a jurisdiction or state other than your state of creation).
In most cases, obtaining a foreign qualification necessitates submitting a request for authorization to the Secretary of State. Additionally, a Certificate of Good Standing from the formation state is usually required. Additionally, each new state will require the LLC to designate and keep a registered agent.
A business must register as a foreign LLC if it is conducting business in a state, which is determined by a number of variables. Among the typical standards are whether your business:
Keep in mind that the requirements vary per state. It is important to consult an attorney to find out if your LLC must be foreign qualified in a particular state.
Choosing a business structure is one of the most essential elements in starting a business. A company’s operations, finances, and legal status can all be significantly impacted by the many business entity possibilities.
A few characteristics (distinct entity classification, limited liability coverage for owners) are shared by LLCs, S corporations, and C corporations. However, there are significant distinctions in ownership, taxation, administration, and other areas.
Doing business as (DBA) is not a type of business structure. It is a document that permits a business to operate under a false or assumed business name.
Both S corporations and LLCs are subject to pass-through taxation. S corporations are not as flexible as LLCs when it comes to distributing profits to their owners. Furthermore, an S corporation could only have a single category of stock. An LLC might have multiple classes of membership interest.
Compared to LLCs, general partnerships & sole proprietorships are easier to start up and manage. They offer a zero liability shield for the owner’s personal assets, though.
1. Establishing an LLC: What documents are required?
Articles of Organization have to be prepared & submitted to the state. A Certificate of Organization is another name for this document. It is also necessary to pay filing costs, any relevant initial franchise taxes, and other initial fees.
2. Does forming an LLC require legal counsel?
Forming an LLC does not require legal representation. The Articles of Organization can be prepared and filed by you. However, it is essential that you comprehend what your ideal condition of formation requires. An attorney can consult with you in the right way.
3. What should my LLC be called?
Selecting a new company’s name is important. Generally, “limited liability company,” “LLC,” or another state-approved phrase or acronym must appear in the name you choose for your LLC. States typically mandate that the name be “uniquely identifiable on the registry” of the state or not “deceptively identical” to any company that is already operating there. You can request a second choice on our LLC order form if it’s conceivable that the name you choose won’t be available in the state of formation or registration.
4. Individuals required to establish an LLC: What is the minimum number?
Owners may be individuals or different companies. It can include corporations and LLCs. The majority of states do not impose restrictions on LLC ownership. Single-member LLCs, or LLCs with just one owner, are also permitted in the majority of states. There is no upper limit on the number of owners.
5. What taxes apply to limited liability companies (LLCs)?
LLCs with a minimum of 2 shareholders are taxed similarly to partnerships. Single-member LLCs are taxed similarly to sole proprietorships.
Additionally, LLCs have the option to choose corporate taxation, in which case their profits are subject to business-level taxation. Depending on the state, the IRS tax implications of LLC losses and profits may or may not be reflected in state law income tax treatment.
Single-member LLCs are exempt from filing an informative tax return, whereas multi-member LLCs are not. Profits and losses are “passed through” the company and recorded on the owners’ tax returns in both situations. The owners then pay any taxes owed at the personal tax level.
Any franchise taxes levied by the state of creation also apply to LLCs. The very right of being an LLC created or registered to conduct business through a procedure known as foreign qualifying is subject to a franchise tax. The amount owed for franchise taxes varies by state and is normally due once a year.
6. How do you run an LLC?
Members of an LLC own the company. These members may be compared to shareholders in a corporate structure or partners in a partnership, depending on the manner in which the LLC is run.
If the LLC designates managers to supervise the LLC’s operations, an LLC member is going to resemble shareholders more. The members don’t take part in management in this situation.
Since each member gets a direct say in business decisions, the members will look like partners if they are in charge of the LLC.
Similar to how partners have a stake in a partnership & shareholders have shares in a corporation, a member’s ownership stake in an LLC is reflected by membership interest.
The standard default rule under state law is member-management. This implies that the members will run the LLC’s operations if managers are not chosen in the Articles of Organization forms.
Which states demand the disclosure requirements of LLCs?
Some states mandate that the formation of an LLC be announced in a newspaper. Arizona, Nebraska, & New York are among the states where this requirement applies to LLCs. In all of these states, an LLC Formation Form order may include the Published Notice of Formation Service.
7. Do I require a registered agent for my LLC?
You must designate a registered agent when you establish an LLC in its home state or register to conduct business in a different state (a procedure known as foreign qualification).
8. How can a limited liability company (LLC) be established?
You must file Articles of Organization LLC paperwork and pay state and initial fees after deciding to create an LLC. It is advised that your LLC call a committee meeting of the managers and members following the filing of your LLC forms. Through the adoption of an operating agreement, the issuance of membership interest certifications to members, and the completion of other preparatory tasks, such as approving the LLC’s bank account establishment, this meeting will aid in the formation of an LLC.
9. Types of LLCs: How many are there?
LLCs can be categorized according to their tax structure, ownership, and management.
An LLC with just one owner, referred to as a “member,” is a single-member LLC. A limited liability company with just one member is automatically considered a “disregarded company” for purposes of federal taxation. Personal assets are still protected by it. You use Schedule C to submit the business’s taxable earnings and expenses, then transfer that data to your private Form 1040.
A professional limited liability corporation (PLLC) may be formed by some professionals who need a state license to operate, such as physicians, attorneys, and accountants. State regulations pertaining to PLLC requirements may differ. While some states refuse to acknowledge PLLCs, others may mandate that specific professionals form PLLCs instead of regular LLCs.
One type of LLC is the Series LLC. It is made up of a parent LLC and one or more independent series that are founded under the parent. The creation of series LLCs is prohibited in some states.
Another option is the anonymous LLC. It lets you keep your ownership details confidential. At the moment, the only states that allow anonymous LLC formation are Delaware, New Mexico, Nevada, and Wyoming.
10. An LLC operating agreement: what is it?
A contract that describes the rules and specifics of an LLC is called an LLC operating agreement. The LLC members often draft the operating agreement. It is required in the majority of states.
11. Does my LLC require an EIN?
Most LLCs will be required to obtain an EIN, commonly known as an employer identification number or tax ID number. In general, this holds true whether or not the LLC employs people.
A single-member LLC without workers or an excise tax obligation is an exception to the rule. (However, the single-member LLC must get an EIN if it intends to hire staff or if it will be tied to excise taxes.)
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