Although limited liability companies (LLCs), are a popular choice when starting a new business, they’re only one option.
This guide will show you how to form an LLC and give you all the information, tips, and tricks that are needed before you do so.
What is an LLC?
It’s exciting to start a business. You may have heard this advice from friends and family about starting a business.
We’ll be covering everything you need about LLCs. You’ll be able to decide if an LLC is right fit for you by the end.
What it is:
An LLC is a type of formal business entity that combines elements of a corporation and components of a general partnership or sole proprietorship.
An LLC, for example, has corporate personhood just like a company. The LLC can purchase property, open a bank account and hire employees. The LLC also provides protection for personal assets. Your personal assets cannot be used as compensation if your business is in debt or in legal trouble. Only the LLC’s assets are available to creditors.
Commonly, members are called the owners of an LLC. Each member may have a different percentage of ownership. An LLC can be owned by one member in some cases. An LLC is a popular option for those looking to start new businesses. It offers personal asset protection and the flexibility to have one or more business owners.
What it isn’t
Although LLCs can be owned jointly by several people, the LLC cannot be purchased to become an owner like a corporation. Although corporations can sell stock to raise capital, LLCs cannot do so. External investments must come from other sources.
An LLC is not required to file the exact same paperwork as a corporation. Because corporations must keep detailed records such as minutes of board meetings and annual shareholder meetings, stock ledgers and other documents, an LLC is a better choice than a corporation.
LLCs must file annual reports along with a few other items. However, the paperwork burden is very low in comparison.
How it’s Made:
LLCs are the most straightforward form of business entity. The LLC’s founder should file the articles to organization with the Secretary-of-State. This document is used to officially establish the company.
The following information is required for articles of an organization:
- Name of the LLC
- The names, addresses, signatures, and contact information of LLC members
- Name and address for your registered agent
- Address in the physical area of the business
- Management style (member-managed, manager-managed).
An operating agreement is necessary for both financial and practical purposes. It outlines how your business operates.
Although you don’t need to file the agreement with the Secretary-of-State in most states you can still make sure that there are no disputes. You can include details such as how much of the profits from the business will be passed to each member, what happens to a member who wants to leave, and how to add members.
There are many ways to create an operating agreement. You can create your own operating agreement with some legal guidance from an attorney. This will ensure that your agreement is tailored to your company’s needs. You can also download a template from an internet business formation service.
You can even hire these companies to help you file the paperwork if you don’t have the time. This would allow you to concentrate on your business idea.
Why is an LLC necessary?
An LLC is very easy to create and maintain. The paperwork required to form an LLC is much less than that of a corporation, and the list of annual compliance requirements are usually quite short.
However, forming an LLC should not be about avoiding the paperwork. An LLC is more complicated than an informal business entity. However, it has one major advantage over a sole proprietorship and general partnership: personal asset protection.
Your personal and business finances will be one when you are a sole proprietor and general partners. If your business is in trouble, your car, your house and any other assets may be used as compensation. You won’t have to worry about this issue if you form an LLC. Your business assets will not be at risk if you do not comply with the state laws. However, your personal assets will be protected by the limited liability feature of your LLC.
The LLC also offers the flexibility to choose the taxation method that suits you best. There are two options: taxation as an individual or as a corporation. Pass-through entities are not required to file their own tax returns. Instead, they will need to submit an informational report detailing how much money the business has earned and lost.
This taxation model allows your members to receive income from the LLC. The operating agreement dictates how much each member will get. Each member reports the income on their individual tax returns and pays any resulting taxes.
The LLC’s total tax liability is usually lower than a corporation. Your members will be required to pay self-employment tax. This is a 15.3% tax that combines the employer-employee portions of Medicare or Social Security.
Your LLC would be taxed as C corporations. The LLC would then pay taxes as an entity using the corporate income tax rate at 21%. This type of taxation would make your members subject to “double taxation,” which is when profits are first taxed at the corporate level and then again at the personal level after the company distributes funds to individual members. This tax option is usually not recommended if your members have high income and can reduce their personal tax brackets.
You can also make an LLC an S corporation. This is a compromise of the options we have discussed. S corp taxation allows you to use most of the pass-through models. However, your owners will not be subject to self-employment taxes because the S corp model treats them as employees. This option is not possible due to many restrictions.
Because of its flexibility and protection of personal assets, the LLC is an excellent choice for many business startup types. The LLC is the best structure for all types of businesses, according to us.
The right business structure for your company depends on many factors such as taxation, personal assets protection, company structure and other important factors.
Advantages of an LLC
1) Simple to create and maintain
LLCs are much easier to set up in America than a corporation.
An LLC’s basic requirement for formation is to file your articles of organization with the state government. Other entity types require more legal hurdles.
In the same way, LLCs don’t have as many maintenance requirements. An LLC must file an annual report along with any state fees. In some states, a franchise tax payment may also be required as part of the maintenance process. These are simple requirements for ongoing compliance.
2) Less paperwork and formalities
Corporations are legally required by law to keep a lot of paperwork. These include bylaws and minutes from shareholder and director meetings.
Many people consider the formalities involved to be too complicated. This is even before we mention the incorporation process, which takes far more effort and time than an LLC.
LLCs don’t have to worry about this. Although an LLC must keep some business records, it is not required to do so in the same way. Meetings are at the discretion of members. Corporations must have meetings for shareholders as well as the board of directors.
3) Personal asset protection
An LLC is a formal business entity and has what’s commonly known as a ” corporate veil.” This veil creates a line between personal finances and business finances.
This division is crucial.
This is why: If an LLC gets into legal or debt, someone must pay, but the corporate veil means that the LLC will cover these costs. Your personal assets and funds cannot be used to make up the deficit if your company’s finances fail.
Let’s take, for example, a bicycle repair shop. A standard tune-up is performed for a client. However, the cyclist crashes because a component you had replaced was damaged. Client, who suffered broken bones from the fall, files a lawsuit for damages. The settlement is not possible because your small repair shop does not have sufficient funds.
If you are a sole owner, this would mean that you would have to pay the expenses out of your personal assets. Your car, house and other personal assets would also be at risk.
This problem would be avoided if you are an LLC. Although it is unlikely that you will encounter lawsuits or debts in your business ventures. However, the corporate veil will protect you from any such problems.
4) Flexible membership structures
Corporations must adhere to strict structural rules that can prove difficult. The LLC is free to design its own managerial structure, but corporations must adhere to strict regulations, including a board, appointed officers and shareholders.
S corporations have additional restrictions. An LLC or C corp can have one member, twelve members or a hundred members, but not S corporations. There is no limit to the number of members that an LLC/C corporation can have.
Your members can also be foreign investors. An S corporation can have no nonresident alien owners and it cannot have more than 100 members.
5) Tax flexibility
LLCs can choose to be taxed either as a corporation, or as a pass-through entity. This flexibility is rare for businesses and allows LLC members to choose the tax method that best suits them.
LLCs often choose the default option which is to be taxed in the same way as a pass-through entity. This tax strategy means that the LLC does not have to pay taxes. Instead, the LLC passes the business income to its members, who then report the income on their individual tax returns.
LLCs are treated the same as corporations, except that the LLC pays the taxes. This requires that the entity pay corporate income tax. It is usually only preferred if LLC owners are wealthy individuals for whom the corporate rate would be lower than their individual tax brackets.
Advantages of an LLC
1) It is more difficult to raise funds via investments
While LLCs can raise capital via outside investments, corporations are more attractive to most investors.
First, LLCs can’t issue stock. Stocks from corporations are preferred investments for almost all private investors. Venture capitalists are unlikely to invest in LLCs because they have a disadvantageous pass-through entity type.
2) Self-employment taxes
Taxation can be a benefit for LLCs but it is a disadvantage when it comes to self-employment taxes.
All LLC owners are self-employed, and therefore subject to the 15.3% self-employment tax rate. This rate includes both the employer portion of Medicare and Social Security. Corporation owners, on the other hand, are not considered self-employed and therefore are exempt from this tax.
3) Laws vary from one state to the next
The downside to the LLC is that each state can set its own rules for how it should be organized and maintained. It can be confusing to understand what your LLC should look like, especially if you have multiple locations.
Additionally, the LLC was only recently introduced to American business. This means that there may be inconsistency or confusion in how courts handle lawsuits involving LLCs in different states.
4) It’s more trouble than running an informal business
Although the LLC is more advantageous than corporations in this area it still takes more effort and time to create and maintain than a sole proprietorship or general partnership.
These informal business structures don’t require any formalities, have no maintenance requirements and are free of fees. While general partnerships and sole proprietorships have significant disadvantages, such as no personal asset protection, the LLC is much easier to set up and manage.
How to form an LLC
It’s now time to begin the process of forming an LLC if you have decided that this is the best option for your company. The exact steps required to form an LLC will differ from one state to the next. Make sure you read the details of each state before proceeding. These are the steps that you will need to follow to create a legal LLC in most states.
1) Name your LLC
It is essential to choose the right business name for your LLC. Names are important as it is your first chance to impress potential customers. You should choose something that is memorable and also highlights the purpose for your business.
It is important to ensure that the name you choose for your LLC is available and not already claimed by another entrepreneur. To ensure you are able to use the name you want, search your state’s business database. It’s a good idea not to choose the first option.
2) Designate an agent registered
Each LLC that operates in the United States must have a registered agent. This role involves receiving important documents from the state, such as annual report reminders and service of process paperwork. It also informs you of receipt and forwards the documents to your company. The registered agent is a point of contact that ensures the state has an accessible point of contact for all companies operating within its borders.
You can name anyone to be your registered agent. Most states have no rules about who can be your registered agent. The LLC cannot serve as its agent. Colorado also requires all registered agents to be at least 18 years of age, but this restriction is not found in other states.
3) Prepare your LLC documents and file them
This is the most crucial step in your LLC creation journey. These documents are commonly referred to as the Articles of Organization by most states, but some states may use alternative names such as the Certificate of Formation.
You will need to provide the following information for filing: The name of the LLC, the principal office and mailing addresses of the LLC, the name and address the registered agent, the members’ names and addresses, management of the LLC by managers or members, as well as the name and address at least one manager or member.
The exact information can be different in each state, and processing times vary from one state to the next. Before you start, make sure you have all the details.
4) Create an operating agreement
Only a few states require LLCs to submit operating agreements to the state. However, we believe that every LLC should have one, regardless of whether or not it is technically required. Operating agreements are important as they outline the business’s operations and can prevent ownership disputes.
The type of information that you want to include in an operating agreement is typically details about the business structure, management, voting rights, capital contributions, distributions, member changes, dissolution process, etc.
Even if your LLC is solely owned and operated by you, an operating agreement should be created. It allows you to separate the LLC from you as a person. This is a critical aspect of personal asset protection.
5) Get an EIN
Next, you will need to obtain a federal tax ID number from the Internal Revenue Service. The EIN is nine-digit number used to identify your company for tax purposes. It is similar to a Social Security Number for individuals. A EIN is a key tool for your LLC to accomplish important tasks such as opening bank accounts, hiring employees, and other financial transactions.
6) Establish the financial infrastructure of the LLC
Next, you will need to open a business bank account. It’s easy to open a business bank account. All you have to do is take your EIN to your bank and inform them that you want to open a business account. After the account has been set up, you must use it only for business income and expenses. It is dangerous to combine your personal and business assets, making your LLC vulnerable to lawsuits and administrative dissolution.
The best solution for your accounting system is to use accounting software such as QuickBooks. You can keep track of all income and expenses for your business in one place. This makes tax time (and legal compliance!) a breeze.
7) Get licenses and permits
While some states require LLCs in order to be able to operate in compliance, others don’t. No matter what state you live in, your LLC likely will need at least one license. There are many industries that either require federal licensure or state licensure (or both). These include agriculture, aviation and mining, firearms, broadcasting and others.
There are also many licenses that county and municipal governments require, such as liquor licenses or occupancy permits. To ensure compliance with licensing and permit requirements, make sure you check with each government agency (federal or state, county, or municipal).
8) Get business insurance
Workers’ compensation insurance is required in all 50 states if your company has employees. Even if your business does not require workers’ compensation, you must still have this coverage. There are many insurance policies available that can be tailored to your industry, including workers’ compensation. A general liability policy is a good option for retail businesses that have customers who visit them in person.
Hire an LLC Formation Service
Do you find this tedious? Do you prefer to have someone else form your LLC so you can focus on growing your business? There are many reputable LLC formation companies that offer professional help for a fraction of the cost of a lawyer.
Many companies offer LLC formation services, so it can be hard to choose the right one. We have compiled our comprehensive guide to the best-rated business formation services online.
All of our readers are encouraged to consult that guide and select the best company for you.
What is the best time to form an LLC?
It can be hard to know when your LLC should be formed. Each business has its own priorities and what works for one entrepreneur may not work for another. We believe it is best to create your LLC before you start your first business transaction.
If you have a business prior to forming an LLC, these transactions will be done by default as either a general partnership or sole proprietorship. These transactions are not protected under the LLC’s corporate veil. This is the layer of separation that the LLC provides between your personal assets and business. Even if an LLC is formed later, the LLC’s corporate veil will not protect you from liability for transactions that you made before your business was formed.
We think that it is a smart idea to create your LLC as soon you have nailed down your business name and concept.
How does the LLC compare to other entities?
We’ve discussed the benefits and drawbacks of the LLC in this article. We have detailed articles on each topic that will help you understand how the LLC compares with a corporation, general partnership, sole proprietorship or general partnership.
Let’s now look at the differences and similarities between each type of business to help you decide if an LLC is right for your company.
- LLC vs. Sole Proprietorship/General Partnership: A sole proprietorship and a general partnership are basically the same thing. Both are informal business entities and don’t need to be formed. The only difference between them is that the sole proprietorship is for one person, while the general partnership is for at least two. These business types don’t provide personal asset protection. This is why we wouldn’t recommend an LLC or sole proprietorship.
- LLC vs. Corporation. This is where things get a little more complicated. There are some clear advantages to the LLC over the corporation. They have flexible taxation, flexible business structures, a simpler formation process and (usually) lower maintenance expenses. The corporation does have some advantages. It can issue stock and attract venture capitalists. Although there are many exceptions, the LLC is the preferred entity type for most small businesses.
Things to consider before starting an LLC
Are you serious about your business?
Although this may seem like a silly question, we are serious. We can’t keep track of how many times people have created LLCs and done nothing with them. We think it is worth taking the time to consider whether you are serious about this before you start the process of forming an LLC. You are ready to start a business. If you aren’t ready to start a business or have a sudden idea, don’t worry!
Are you looking to expand into other states?
If your intention is to only operate your business in one state then you can form an LLC. A corporation may be better suited if your plans include doing business in several states. Corporations are identical in all 50 states while each state has its version of an LLC. The legalities and structure of a corporation will remain the same across the United States, while the LLC can vary from one state to the next.
How much do you have to spend?
It depends on where you live, the cost of forming an LLC may be high. Although some states charge a small fee to create an LLC, others charge hundreds of dollars. You might have to put off your business plans if you are operating on a tight budget.
Are you open to outside investments?
LLCs are not attractive to outside investors. They can’t sell stock which gives corporations an unbeatable advantage. Venture capitalists are not likely to invest in LLCs (although it does happen, it is rare).
The Real Cost of Forming an LLC
One of the most frequent questions entrepreneurs ask is what it costs to form an LLC. Apart from the filing fee, there are many additional costs associated with LLC formation. You should note that each state has its own LLC formation fees. The additional costs may vary from one state to the next, and sometimes even industry to industry.
Let’s look at some other costs. A name reservation fee is not usually required. It is required in Alabama, but it is optional elsewhere. A name reservation fee is minimal in most states. In many cases, it will cost between $10-20.
You can also add costs by using an LLC formation service. Most of these companies charge additional fees to set up the LLC. Your new LLC’s bottom line will be affected by whether or not you choose to use a registered agent service. Your expenses will increase if you choose to have an attorney assist you.
There’s also the matter of annual and initial reports. Although initial reports are not required in all states, they are an important part of the formation process for those states that require them. Annual reports are required by most states. The costs for them can vary from $10 in Colorado to $520 in Massachusetts.
Even though LLCs are generally pass-through entities there may be state-specific tax responsibilities such as franchise taxes to allow an LLC to do business within the state. There are a lot of costs associated with LLCs. Others can manage to do so for much less. It all depends on the location of your company and what business line it is in.