Forming a Limited Liability Company (LLC)
WHAT IS AN LLC?
A Limited Liability Company (LLC) is a type of legal entity that can be formed to own and operate a business. As its name suggests, this form of business is the safest form of business ownership as it protects its owner from personal legal liability. An LLC Is a fusion of a partnership and a corporation.
ADVANTAGES OF AN LLC
Personal Asset Protection. An LLC presumes the limited liability of its owner. This means that as an LLC owner you cannot be held personally liable for any debts or losses incurred by your LLC business. Since an owner of LLC cannot be personally liable, creditors or individuals who file lawsuits against your company will not be able to go after your personal assets (i.e., your personal bank accounts, your home, or your car). They can only collect from your LLC’s assets (banks accounts or property registered to your LLC).
Simplicity. A Limited Liability Company is the simplest business entity to establish and operate. An LLC structure is much simpler than any corporation, as it does not require to have officers and directors, to hold board and shareholder meetings, or to have other administrative obligations of a corporation.
Pass-Through Taxation. Pass-through taxation means that the income taxes of a business are “passed through” to the owner of that business. So, your LLC as a business entity is not taxed, but as an owner of an LLC you report all income and deductions on your personal taxes.
If you are a sole owner of your LLC, your company is taxed the same as s sole proprietorship, which means you should report your LLC’s profits, losses, and deductions, and file it with your personal return on IRS 1040 Form. If your LLC was formed with two or more people, it is then treated as a partnership for tax purposes. This means that all profits and losses are reported through the owners’ personal tax returns and taxed at their personal rates.
Usually, as an LLC owner, you can qualify for the special pass-through tax deductions established by the Tax Cuts and Jobs Act, which came into effect in 2018 and is scheduled to continue through 2025. You can qualify for an income tax deduction of up to 20% of your net business income earned.
Flexibility. An LLC allows great flexibility when it comes to ownership, management, and taxation. It has no minimum or maximum limits on the number of owners (or members), so you may be the sole owner of your LLC or have hundreds of owners (members). An LLC does not require a formal structure of ownership, so you are not obliged to elect a board of directors, hold regular meetings, and maintain any records of the management/director meetings. An LLC allows one or several managers to run the business, who can be owners/designated members, nonmembers, or a combination of both.
Also, LLCs have flexibility in choosing how they want to be taxed. An LLC can select between being taxed as sole ownership or partnership, or if you are a multi-member LLC, you can choose to file taxes as a C corporation or an S corporation. To choose the way of taxation you just need to fill out an election, a special document filed with the IRS.
Credibility. Running a business as a Limited Liability Company gives you more credibility. When your potential clients see LLC next to the name of your company, they feel more assurance that you are a real business.
DISADVANTAGES OF AN LLC
Investment Disadvantages: Because LLC does not allow outside investments, this form of business is not the best for people who plan to engage investors or venture capitalists for funding your business. In this case, corporations are better as they allow stocks to be issued in exchange for investors’ money.
Cost: Generally, the costs of forming an LLC are higher than to be a sole proprietor or have a partnership. Expect to pay filing fees to legally establish the LLC. Once you form the LLC, you will also need to pay annual fees and taxes to the state where your LLC is registered.
HOW TO START AN LLC
It’s relatively easy to form a Limited Liability Company. You will need to file articles of organization or a similar document with your secretary of state's office and then complete a few other formalities to get your LLC up and running. Each state has its own unique LLC formation requirements.
To start an LLC, you need to:
1. Choose a name for your LLC
Most states do not allow two different business entities to have the same name. For example, you cannot register your business as “Edible Gifts, LLC” and “Edible Gifts, Inc”, even though you have locations in different cities. Many states also restrict companies from using certain words in their names. Before you give your LLC a name, check the internet to make sure your unique name is not taken already.
2. Optional: reserve a name
If you came up with the perfect name for your LLC, but are not ready yet to file your LLC documents, you can reserve the name for your business. Nearly all states allow a future business owner to reserve a name by filing a special form and paying a name reservation fee. The period of name reservation and the costs vary in different states. If the name you’ve selected for your LLC is available, but you aren’t going to be filing your LLC documents right away, you may want to reserve the name. Nearly every state allows you to reserve a name by filing a form and paying a name reservation fee. The length of the reservation period, filing fees, and renewal policies vary from state to state.
3. Choose a Registered Agent
Most states require that an LLC assigns a registered agent (also called a statutory agent). This is a person who agrees to receive lawsuits, subpoenas, and other documents on behalf of the LLC and to give them to the appropriate person at the LLC. Any state resident over 18 years of age can serve as a registered agent. You can also hire a company that will provide your LLC with a registered agent for a fee.
4. Prepare an LLC operating agreement
An LLC Operating Agreement is the document that describes how your LLC will be operated. An LLC operation agreement covers such items as the ownership interests and voting rights of the members, how profits and losses will be distributed, how the business will be governed, etc.
This document is not required to be filed with the state. Moreover, not all states legally require that you have one. However, if your LLC has more than one owner/member it is a useful document to have to minimize any potential future disagreements between the owners.
5. File organizational paperwork with your state
Most states require to file the Articles of Organization that will cover the following things:
- The name and address of the LLC
- The name and address of the registered agent
- The purpose for which the LLC was formed
The Articles of Organization are typically signed by a person who forms the LLC, although, some states require that the registered agent also signs it. In most states, the office of the Secretary of State handles the business filings and collects filing fees.
6. Receive a certificate from the state
After the Secretary of State office receives and registers your LLC formation documents, it should issue a certificate confirming the formal existence of your LLC. With this certificate, you can obtain a tax ID number, a business license and open a business bank account.
