By 
When starting a business, you have a series of decisions to make, and one of the first is the type of business entity to form with your state. Many entrepreneurs choose to form a limited liability company (LLC), which offers many advantages compared to the other choices.
Here we’ll provide everything you need to know about an LLC so you can decide if it’s the right choice for you.
Features and Benefits of an LLC
An LLC offers several features that are beneficial to its owners, who are called members.
Limited Liability Protection
As its name states, an LLC offers limited personal liability protection for its members. The LLC is a separate entity from its members, and it has its own assets and debts. This means that the LLC itself is responsible for the obligations of the business, not the members. If the LLC cannot meet its obligations or is sued, the members are not personally liable.
So, as a member of an LLC, your personal assets of any kind are not at risk. This differs from a sole proprietorship or a general partnership. In those cases, the business and the owner or owners are one and the same and are therefore personally liable for the obligations of the business, which puts their personal assets, including their homes, at risk.
There are a few cases in which the liability protection of an LLC does not apply, hence the word “limited”. For example, if you get a business loan for your LLC, the lender may require that you personally guarantee the loan, which is common. Doing so makes you personally liable for the debt, putting your personal assets at risk.
Other exceptions will occur if a member commits fraud or personally injures someone in the course of business.
Tax Advantages
An LLC is, by default, a pass-through entity, meaning that profits or losses are passed through to the members to be reported on their personal tax returns. The LLC itself is not taxed, which differs from a corporation which must pay corporate income taxes. The dividends paid to corporation shareholders are also taxed, which is referred to as double taxation.
If the LLC has only one member, it’s considered a disregarded entity and taxed as a sole proprietorship, so all profits or losses pass through to the single member.
If the LLC has more than one member, it’s taxed as a partnership, and profits or losses are passed through to the members in amounts generally based on their ownership percentages.
However, LLCs are unique in that they can choose to be taxed as a corporation or an S-corporation. In some cases, this is beneficial because then members will not responsible for self-employment taxes. Members of a pass-through entity are subject to self-employment taxes.
Simplicity
An LLC is much easier to form and maintain than a corporation. Corporations are required to have a board of directors and are subject to annual meeting and specific reporting requirements, while an LLC is not.
Corporations, due to their complexity, are also best formed with the assistance of an attorney, which is an added cost.
Flexibility of Profit Sharing
Members of an LLC can decide on any profit-sharing structure that they choose, rather than being bound by structuring it based on capital contributions. For example, if one member is more involved in the business, they can receive a higher percentage of profits than other members, even if all members contributed the same amount of capital.
The members have to all agree on the structure chosen and it needs to be specified in an operating agreement, which defines the ownership and profit-sharing structure and contains other important provisions.
How to Form an LLC
If you decide that an LLC is the right business entity for you, you’ll need to know the steps to take to form an LLC.
Check Name Availability
You’ve probably chosen a name for your business, but you need to make sure it’s available to use. The first step is to search your state’s business database, which is usually on the Secretary of State’s website. You should search for the specific name you’ve chosen as well as similar names.
You’ll also need to check your state’s LLC name regulations. Your state will require that your name contain “limited liability company”, “LLC”, or “L.L.C.”, and will have other naming rules that you need to follow.
You’ll also want to make sure the name is not nationally trademarked by checking the USPTO website.
Finally, do a domain name search on a site like GoDaddy to see if the domain name is available to use.
Select a Registered Agent
A registered agent is a person or company appointed to accept important documents on behalf of your LLC. A registered agent is required in almost all states. Each state has rules regarding who can be an LLC which generally include the following:
- Must be 18 years or older if the registered agent is an individual
- Have a physical address in your state
- If the agent is a business, it must be registered to operate in your state
- Must be available at their registered address during normal business hours
You can be your own registered agent, but then you have to be available at your business address during business hours, which can keep you from doing things necessary to growing your business.
Determine Your Management Structure
You have two choices of management structure:
- Member-managed, meaning all members have a role in the management of the company
- Manager-managed, meaning that outside managers are hired to manage the company, which they can do in conjunction with a member, or without
Some states require that you specify your management structure in the documents you file with the state to officially form your LLC.
File State Documents
In most states, the document you file to form your LLC is called the articles of organization, while in others it’s called a certificate of organization or a certificate of formation.
In most states you can file the document online, usually on the Secretary of State’s website. The information required varies by state, but generally includes the business name and address and the registered agent’s name and address.
Fees also vary by state and range from $40 to $500.
Draft an Operating Agreement
An operating agreement, as mentioned earlier, defines member ownership percentages and how profits are distributed. One is not required in most states, but it’s critical to have. Even if you’re going to be the only member of the LLC, an operating agreement will define how you can add a member later, or what happens to the LLC if you’re disabled, or the worst-case scenario happens.
The operating agreement will also define how the LLC is managed, and the roles and responsibilities of members or managers.
Because of the critical nature of the operating agreement, it’s best to have an attorney’s help when drafting it. You want to make sure that all based are covered and that the interests of the members and the business are protected.
Next Steps
You’ll have a few more things to do to get your LLC fully operational.
- Check with your state and local governments about licenses and permits that may be required
- Get business insurance
- Get an Employer Identification Number (EIN), which is like a social security number for your business and is used for tax reporting purposes
- Open a business bank account
- Determine how the LLC will be taxed (with the help of a tax advisor)
- Check LLC annual reporting requirements in your state
In Closing
As you can see, there are good reasons that many entrepreneurs choose to form an LLC rather than a different type of business structure. It offers many benefits including, perhaps most importantly, personal liability protection. If you’re in doubt, check with your attorney and tax advisor about the right option for you. You want to get your business off on the right foot so that you have the best chance of building a successful company.
Author: Carolyn Young
