The ABC’s of starting an LLC
Starting a business comes with some big decisions. One of those decisions is what type of business structure you want. You’ve likely heard of a sole proprietorship, a partnership, or a corporation. But have you considered an LLC? If not, read on for more information that can help you to decide if this type of business structure is right for your company.
Advantages (And Disadvantages) of LLCs
A Limited Liability Company, also known as an LLC, is a flexible structure, offering elements of a sole proprietorship, a partnership, and a corporation. Creating an LLC limits the personal responsibility that the business owners face regarding the business’ debts and lawsuits.
The Advantages of LLCs
The structure of an LLC is most beneficial to:
- Businesses that are likely to acquire debt or have the potential of lawsuits — The business doesn’t have to be engaged in dangerous activities to face debt or lawsuit potential. Simply having a shop where you allow the public to enter and purchase items leaves you open to the possibility of claims if someone were to slip and fall. Unlike a sole proprietorship or a partnership, an LLC limits the personal assets of the business owner from becoming a chess piece in settling claims or collecting assets to satisfy a debt.
- Those who want flexibility. You can have as few or as many owners — referred to as members — as you’d like. The members aren’t required to be citizens of the U.S. or even permanent residents. In fact, they can be individuals, corporations, foreign individuals or corporations, or even other LLCs. The LLC can also just be you. It’s your choice to make.
- Those who want a simple structure. The process of becoming an LLC is quite simple. Many states allow you to simply file your Articles of Organization with the Secretary of State’s office and pay a filing fee.
- Those who want the tax benefits of a corporation without the hassle. Unlike a corporation, you’re not required to fill out corporate income tax returns with an LLC. You simply list your profits and losses on your personal return and get the pass-through tax benefits that a corporation provides.
- Those who want the heightened credibility that comes from having a business that is not a sole proprietorship or a partnership. Often sole proprietors and partners are referred to as “mom and pop” businesses. While there’s nothing wrong with that, the LLC can appear and sound a bit more official to partners and lenders.
- Those who don’t want to be bogged down with compliance issues. All other business structures are heavier on the formalities.
The Disadvantages of LLCs
Like any business structure, not everything is perfect in the world of an LLC. Some of the disadvantages of this business type include:
- Eligibility issues. Not all types of businesses are eligible. For example, banks and insurance companies are prohibited from being LLCs. In some states, other professions are also banned from creating LLCs, including architects, accountants, doctors, and healthcare workers.
- Limited growth potential. LLCs cannot issue stocks to investors.
- Potential liability. If you fail to meet the state’s regulations for starting and maintaining your LLC, or the IRS or state believes you have used the business to commit fraud, you could lose your liability protection.
- Lack of uniformity. The laws and requirements surrounding LLCs may be vastly different from state to state. Additionally, this business structure is only recognized in the U.S., meaning you are unable to go to a foreign country and start an LLC there.
- The potential of increased taxes. Some LLC members face taxes such as the self-employment tax or appreciation of assets.
- Start-up expenses. The filing fee for forming an LLC is often more expensive than forming a sole proprietorship or a partnership. States may also charge ongoing fees to maintain the LLC.
- Risk of dissolution. Depending on state laws, an LLC may be dissolved if one partner dies or files bankruptcy.
Business Structure Comparison
So how does an LLC stack up against other structures? Let’s take a look.
LLC vs. Sole Proprietorship
Unlike an LLC, sole proprietors are not required to pay a filing fee to start up. Both of these business structures allow you to claim the company’s profits and losses on your personal income tax return. Sole proprietors are not afforded the same personal liability benefits from the business’ debts and legal claims. Creditors can go after the sole proprietor’s home, vehicle, bank accounts, and other assets in order to satisfy debts.
LLC vs. Partnership
LLCs are not recognized by the IRS as a business entity. Rather LLCs are allowed to be taxed as a partnership, a sole proprietorship, or a corporation on tax returns. An LLC is considered an independent legal entity, which is what provides the personal asset protection for members.
A partnership, on the other hand, is a business that operates under the names of its owners. When a partnership owes money or faces legal liability, so do its partners. Partnerships are disregarded as business entities, and business income is taxed as personal income in proportion to each partner’s ownership of the business.
Each of these structures provides flexible management that is largely up to the owners/ members to decide. LLCs may have an operating agreement that is similar to the partnership agreement in the delegation of ownership and responsibilities.
LLC vs. S-Corp
The biggest difference between an LLC and an S-Corp is in how each business structure is taxed. An LLC’s business profits are taxed as personal income on the members’ personal tax returns. The S-Corp is not an actual business entity, but a designation for tax purposes. The owner only pays Medicare and Social Security taxes on his or her own salary, but not on other business profits.
LLCs can actually choose to pay taxes as an S-Corp and may save money by doing so. Not all businesses are eligible for S-Corp status, however, including LLCs that are owned by foreign entities or have an owner who is a foreign citizen, as well as those that have a single owner and are structured where the owner is a partnership or a corporation.
LLC vs. Corporation
Like LLCs, corporations are also considered their own legal entity and shareholders are limited in the business debt and legal liability. Corporations pay taxes on their profits as well as tax on the dividends distributed to shareholders. The dividends are then also taxed as personal income for the shareholders, resulting in double taxation. However, this double taxation is often offset by federal deductions made available only to corporations.
Corporations are heavily regulated, requiring a number of business formalities, including an annual shareholder meeting that must be reported to the state. Corporations may increase their profits and grow through the sale of stocks. An LLC cannot issue stocks to investors. LLCs may add owners regardless of the financial contribution that anyone pays as part of that ownership. The liability protections afforded to a corporation have been around much longer than those pertaining to an LLC and therefore tend to be uniform from state to state.
Creating an LLC
Choosing a State
While you can form an LLC in a state where you don’t plan to do business, most LLC members opt to form in a state where they either reside or where their business is going to be active. Some states provide an easier process for forming an LLC. However, forming an LLC in a state where you do not reside may increase your formation and administrative costs.
Choosing a Name
Your name is how others will know your business. You will want to put a lot of thought into deciding what to call your business, as changing it later isn’t necessarily the best thing for your business’ credibility, and it may even be impossible to change it. You want to make your business name memorable, reflective of the products or services you provide, and original. The name cannot already be in use by another LLC in your state.
Also, make sure it’s legal. Many states have required words and restricted words when it comes to business names. You will want to include the words “Limited Liability Company” or “LLC” in your name. Obviously, profanity is not a good idea when it comes to choosing a name. States also prevent LLCs from using the words “Bank” or “Insurance” in their names, as well as other words. If you aren’t sure if the words included in your desired business name are legal, check with your Secretary of State’s office to see if they can provide you with a list of restricted words.
Do You Need a Registered Agent?
If you are forming an LLC in a state where you do not reside, you must have a registered agent. A registered agent is an individual or entity authorized to accept service of legal process, tax notices, notices sent to you by the Secretary of State, garnishment orders, and subpoenas. The registered agent must have a physical address within the state and must be generally available to accept these important documents for you.
The Operating Agreement
While these documents are required in every state, some states only require you to have an oral agreement. However, developing a written operating agreement is strongly recommended, as it signifies that the LLC is an official business if a question of debt or legal liability of the members ever arises. Some of the issues that an operating agreement may address include:
- The authority designated to each of its members
- When a vote is needed to approve transactions
- Transferring interests to new members or adding new members
- How profits and losses should be split among members
An operating agreement allows the members of an LLC to decide their own destiny. In the absence of a written operating agreement, if there is a discrepancy among members, the state’s default rules will apply.
Filing Your Articles of Organization
The Articles of Organization generally requires very basic information, including the business name, location, names and addresses of the members and the registered agent (if required). Before paying to file with the Secretary of State’s office, ask if there are any extra requirements you should know about, such as publication of the Articles of Organization in the local newspaper.
In addition to the steps previously listed, you will need an Employer Identification Number (EIN). As an LLC, you will use it on business bank accounts and tax filings. You may also need a sales tax identification number if your business provides taxable products for sale.
You may also need to open a business bank account. While you’re not legally required to do so, it is generally good business practice to keep your company’s banking business separate from your personal banking. This also further reinforces the limited liability aspect of your business structure.
And if you plan on doing business in other states, you will need to register your business in those states in accordance with each state’s laws.
Converting to an LLC
You may also convert an existing business to an LLC structure. In order to do so, some states only require the filing of your Articles of Organization as if you were starting a new business. In all states, the conversion will require that you transfer your federal and state EINs, sales tax permit, business license, and other professional licenses to your new LLC.
It’s an Important Decision
Your business structure is one of the most important decisions you will make in starting your business. An LLC, while not as commonly discussed as other structures, is a viable option for many businesses that seek the liability protections of a corporation and the simplicity of a sole proprietorship.
Ultimately, it’s your decision and you should take into consideration the type of business and your business needs.
Originally published at https://origin-x.legal on January 16, 2020.