What Is an LLC?
A Limited Liability Company, commonly referred to as an LLC, is a business structure that offers certain protections to its owner(s) when it comes to lawsuits and personal asset protection. An LLC can be a great choice for many individuals who want to start up their business easily and with little stress, but there are a few disadvantages of an LLC that you should also know about.
In this article, we will be discussing exactly what an LLC is and the benefits that it can offer you. We will also be giving you information on the different types of LLCs out there, answering some of your most important questions about LLC formation, and providing you with an overview of the LLC establishment process.
Should You Form an LLC for Your Business?
No matter if you are a first-time business owner or looking to convert an existing business into an LLC structure, you may be wondering whether you should form an LLC to conduct your business under. In general, forming an LLC can help protect your personal assets against lawsuits or business debts while making your business appear more legitimate to customers. An LLC may also help to streamline your business taxes and is easier to start up than a corporation or other legal business entity would be.
To help you make your decision, we’ve compiled a collection of the pros and cons below that can give you a good idea of what starting an LLC would be like for you.
Benefits of Starting an LLC
There are several benefits of starting an LLC that you may want to take advantage of by forming this entity type.
Personal Asset Protection
The “limited liability” part of an LLC’s name comes into play with this benefit. Once you have formed your LLC, you will not be personally liable for any debts or lawsuits that your business experiences. This means that your personal assets and finances will be safe from collections or legal judgments – only your business’s assets and bank account will be liable in these situations.
Forming an LLC for your business adds an extra layer of protection that you may want to take advantage of.
Flexibility
As you learn more about forming an LLC, you will come to realize that there is a great amount of flexibility afforded by this entity type. For example, there can be any number of members or managers in an LLC, and you can choose how your business pays taxes and establish rules for how you want your business organized or operated. This makes an LLC the prime choice for a business owner who wants ultimate flexibility when running their business.
Improved Credibility and Reputation
After your LLC is established, you will have an official business name that you can use and, optionally, matching domain names for a business website. This helps to build your credibility and reputation with customers and may make your business seem more trustworthy. Over time, this can bring you more business and improve your reputation in the community.
Taxation Benefits
In general, LLCs are taxed as pass-through entities. This means that any profits or losses that your business experiences will pass through to you and be filed on your personal tax return; they will be taxed at the state or federal individual income tax rate, which is often lower than a business or corporate tax rate.
However, you may also choose to be taxed as a different entity with an LLC if that fits your business’s purpose more. To do this, you will need to file specific forms with the IRS to be treated as either an S or C Corporation. After this is declared, you will pay taxes for your LLC as if you were one of those entities. More information on this process and its potential benefits can be found here.
Simple Operations
One of the best things about starting an LLC is that it is relatively easy to start up and run this entity type. An LLC doesn’t have the requirements that come with forming a corporation (such as organizing boards, shareholder meetings, or appointing directors), and the steps to form an LLC are pretty straightforward in most states. It is also easy to dissolve an LLC as soon as you have finished conducting business under it.
Disadvantages of Starting an LLC
Like with all business entity types, there are a few disadvantages to running an LLC. We discuss these below so you can decide if any are a dealbreaker for you.
Cost
While starting and operating an LLC may cost less than starting up a corporation, it can cost more than creating a sole proprietorship. The cost of starting an LLC includes filing fees for the various required documentation, reservation fees for business names or assumed names, and annual business taxes or report fees. Depending on the state and how profitable your LLC is, this can cost between a couple hundred all the way up to several hundred or even a few thousand dollars per year.
Annual Requirements
LLCs are often required to meet annual requirements and file ongoing documentation with the state they are established in on a regular basis. There are usually fees associated with annual filings, and failure to file or late filing can result in either involuntary dissolution by the state or a negative standing. This can be difficult to keep up with, and some individuals may opt for an entity that doesn’t require annual filings, such as a sole proprietorship.
Investment Potential
Finding investors and other outside funding sources (outside of bank loans and credit) can be difficult for LLCs because this entity type is not as friendly to investors as a corporation would be. It can be complicated for investors to become involved in something that is essentially a pass-through entity in terms of taxes. The paperwork and legal workarounds are often so complex that investors steer clear of LLCs altogether. More about this specific drawback can be read here.
Types of LLCs
When deciding whether or not to establish an LLC, you may come across several different types of LLCs. While they are all limited liability companies, there are several differences between each entity type that it is important to understand.
Domestic LLC
Domestic LLCs are the most common type of LLC – they are a limited liability company that has been established in one state and operates out of that same state. Most articles that refer to “LLCs” are referring to domestic LLCs.
Foreign LLC
Foreign LLCs are those that have been opened up in one state but then decide to conduct business in a different one, in addition to their home state. For example, if you establish your LLC in Florida but later decide you also want to conduct business in Georgia, you would have to register your business as a foreign LLC in Georgia.
Series LLC
A series LLC is one that involves a parent LLC providing protection to a series of ‘child’ businesses that function as individual protected series. Every individual business will be protected from liabilities under the overarching parent LLC. Depending on state rules, your individual series LLCs may be required to register as separate foreign or domestic LLCs in a state, and you may be required to pay varying amounts of taxes on the LLCs underneath your parent business.
You should also note that only certain states and districts provide for the formation of series LLCs. These are as follows: Alabama, Delaware, Washington D.C., Illinois, Indiana, Iowa, Kansas, Minnesota, Missouri, Montana, Nevada, North Dakota, Oklahoma, Tennessee, Texas, Utah, and Wisconsin.
Professional LLC
Professional LLCs are similar to domestic LLCs, but they are generally formed by licensed professionals, such as attorneys or accountants. To form a professional LLC, you will need to meet applicable state or national licensing requirements in addition to filing state-specific professional paperwork upon formation.
It is also important to note that the liability protection your LLC offers will not apply to malpractice claims against you. However, if the malpractice claim is against one of the members of your LLC, you will not be liable for any judgment or settlement made against them; this is different than if you had established a professional partnership, where all members would be responsible for a malpractice claim against one individual.
How To Start Your Own LLC
The exact rules for starting your LLC are highly dependent on the state where you are establishing your business. That being said, there are some general requirements that you can expect to meet no matter which state you are setting up your business in.
You should keep in mind that these general guidelines apply to domestic LLCs; other LLC types may require you to file different paperwork or meet certain regulations.
Choose a Name
One of the most important steps in starting your LLC is to choose a name for your business that is unique from others in your chosen state and doesn’t risk infringement. Most states will have LLC naming rules that you will need to follow in addition to providing a business name search, so you can ensure that the name you select is unique.
At the same time, you may also want to perform a search of available domain names in order to establish a business website. You most likely won’t need a business website immediately, but purchasing the domain name ahead of time can be helpful in saving you from future stress.
Appoint a Registered Agent
Almost every state will require your LLC to appoint a registered agent, also sometimes called an agent for service of process, before filing to establish your business. Your registered agent will be responsible for handling all communications between your LLC and state or federal agencies and will be the party that is contacted in the event of a lawsuit against your business.
Many states will allow members of your LLC, an outside individual, or a business authorized in that specific state to act as your registered agent. Some states may also provide a public list of commercial registered agents in the state to choose from as you decide who to appoint.
File Establishment Paperwork
An essential step in establishing your LLC, you will need to file Articles of Organization with your chosen state to officially establish your business. This document is also sometimes called a Certificate of Formation or a Certificate of Organization.
On this form, you will be required to put important information about your business, including its name, organizational structure, and general information, and key members of your LLC may be required to sign the document.
Most states will allow you to file this document online, but some states may require you to file by mail or deliver the form in person. Filing fees vary from state to state, but you can expect to pay anywhere between $50 and $300 to file this form.
Decide on Organizational Structure
After you have filed the applicable establishment paperwork in your chosen state, you may be required to file additional organizational paperwork, such as an Operating Agreement. Even in states where it is not required for you to file an operating agreement, it may be a good idea to draft one up anyway.
An operating agreement can help you decide on all organizational structures, including whether or not you want your LLC to be member-managed or manager-managed, and can set clear guidelines for the operation of your business and what to do in the case of a lawsuit or business dissolution.
It is important to note that if you choose not to develop an operating agreement for your LLC, you may be subject to the state’s LLC laws in the case of a dispute or lawsuit, and this is not always going to be in your favor.
Obtain an EIN
Depending on what you want to do with your LLC, you may not need to obtain an Employer Identification Number (EIN). LLCs that will be hiring employees (including single-member LLCs) or an LLC that has multiple members are both required by the IRS to receive an EIN.
The EIN will function much like a social security number for your business and will be used on all federal tax returns. You can also use your EIN to register your LLC with the state it is established in and pay applicable taxes.
Filing for your EIN is free and can easily be done online through the IRS’s website.
Meet Additional State Requirements
Ongoing and additional state requirements for LLCs are highly dependent on specific state rules, but there are several things that you might encounter. Annual report filing is common for most states – this involves your LLC filing a report by a certain due date each year (or every other year in the case of biennial reports) and often paying an annual filing fee.
Alternately, you may encounter publication requirements in certain states, have to pay LLC-specific business taxes on a regular basis, or be required to register for state business licenses and employer taxes. It is important to check with state requirements through the Secretary of State’s website, the state licensing board, and the state’s department of revenue to ensure that you meet all ongoing and additional requirements.
Frequently Asked Questions About LLCs
These frequently asked questions can help you to understand more about what an LLC is and whether or not you want to start this business type.
How Are LLCs Taxed?
LLCs are typically taxed as pass-through entities, which means that any business income or loss is accounted for on the owner’s personal income tax return. However, you can elect to tax your LLC as an S or C Corporation and may be liable for additional state taxes (this depends on state rules and the type of business you are running).
If you have any questions about your tax burden once your LLC is established, you should meet with a local tax professional in your business’s state and ensure that you are meeting all state and federal tax requirements.
How Much Does It Cost To Start an LLC?
Because state LLC establishment costs vary, there is no one set amount that it could cost to set up your LLC. In general, you will need to pay the cost of filing your Articles of Organization to establish your business in a state – this typically costs between $50 and $300. You may also need to pay other state fees associated with LLC name reservations, trade name registrations, and publication notification requirements.
Do State LLC Laws Vary?
State LLCs laws can vary greatly, which is why it is so important to consult with local regulations and state agencies in the state that you want to establish your LLC. You should carefully review all filing requirements and applicable fees in order to understand the LLC setup process in your chosen state and start your business with less stress.
Do You Need a Lawyer to Form an LLC?
You do not need a lawyer to help you form your LLC, and hiring one may be on the expensive side. Unless you have certain tax and legal concerns that are specific to your business, you should be able to file all of the state paperwork necessary and create the internal documents needed to efficiently run your LLC without legal advice.
How Is a Sole Proprietorship and an LLC Different?
In a sole proprietorship, one individual owns all of the assets of the business and their personal assets; there is no distinction between the two, which can make the individual personally liable if something goes wrong with their LLC.
A limited liability company is a separate business entity and offers a separation between personal assets and business assets that can help protect the owner(s) in the case of business debt or a lawsuit.
How Is a Corporation and an LLC Different?
Corporations provide liability protection much like LLCs, but more rules and regulations are involved in setting up a corporation. Members of either an S or C corporation must be treated as employees, whereas members of an LLC are treated as self-employed. Additionally, corporations are treated as separate tax-paying entities and must file separate corporate tax returns federally and sometimes on a state level.
You can read more about the differences between these two entities here.
How Do You Pay Yourself From an LLC?
As you run your LLC, you are able to pay yourself by making a distribution to yourself. This income is then taxed on your individual income tax return. However, if you are electing for your LLC to be taxed as an S or C corporation, you will need to set aside a reasonable salary to be distributed to yourself. It is also important to note that specific LLC tax structures and business types may dictate the way you get paid.
If you have questions about this process, you can read this article or meet with a local financial advisor to get your personal payments and overall tax burden in order.
Choosing the Best Business Entity for You
As you start up your new business, the decision over which entity type to form can be a difficult one to make. After all, you want to be sure that you get the most advantages out of your business type and minimize any disadvantages that may be present. While starting an LLC may be the best choice for many individuals, you should make sure to carefully review the pros and cons of this business structure before planning your next move. From there, you can make an informed decision about the entity type and ensure that your business maximizes its success.