Limited liability companies or LLCs have become a popular choice among small business owners looking for liability and asset security with tax benefits. With no unnecessary documentation and paperwork, LLCs remain a commonly chosen option among sole entrepreneurs.
But before you dive into forming an LLC, you need to do your homework. Read on to know everything there is to know about LLCs.
An LLC is a useful business entity for small business owners. It is essentially a mix between a corporation and a sole proprietorship. Like a corporation, an LLC offers business owners limited liability in adverse times like lawsuits or bankruptcy.
An LLC also offers the flexibility to be taxed as a pass-through entity avoiding double taxation and instead gets taxed only once under owners' tax. The IRS reported that there were over 26 million LLCs operating as of the tax year 2017.
There are many advantages of forming an LLC, including tax benefits and limitation of personal liability. Here’s a rundown of some key advantages of forming an LLC:
One of the major advantages of forming an LLC is limiting your liability to the company. LLCs are recognized as legal entities with their own identity and ensure that creditors cannot pursue your assets to settle business loans.
Other structures of companies such as sole proprietorship and partnership do not distinguish between the company’s assets and the owner’s assets. With an LLC, personal assets are also protected in case an employee or stakeholder in the business is sued for negligence.
An LLC is perfect for smaller businesses that cannot meet the requirements of corporations, such as holding annual shareholder meetings or making reports. On the whole, LLCs involve a lot less paperwork which makes them easy to maintain and more functional for small to mid-size companies.
LLCs offer major tax benefits, and forming one is a smart tax planning move. This is because they lack their federal tax classification, allowing them to adopt the tax states of sole proprietorships, partnerships, S corporations, or C corporations through Form 8832.
Forming an LLC means you can benefit from the ‘pass-through taxation’ scheme of sole proprietorships. Here, the profits of the business are taxed as the personal income of the owner.
C corporations have a more complex taxation structure, where they are taxed twice on paying shareholders at the corporate and individual level.
Other structures of businesses like S corporations have a fixed cap on the number of shareholders the company can have. But LLCs allow you to enjoy the benefit of pass-through taxation without the ownership constraints of S corporations.
Also, corporations are required to distribute profits among shareholders based on ownership percentages, but not LLCs. This flexibility in ownership makes LLCs a great option for small businesses.
While there are upsides to forming an LLC, it’s important to consider the disadvantages, too:
Employees of LLCs who receive fringe benefits such as medical insurance, reimbursement plans, parking, and group insurance must report these benefits as taxable income. However, employees of C corporations do not necessarily have to do so.
In certain instances, LLCs can have a higher tax liability than their corporate counterparts. Both salaries and profits of LLCs attract self-employment taxes; however, only salaries attract such taxes in a corporate structure.
Since LLCs have an existence independent of their owners, it’s crucial to maintain separate books of accounts for the LLC and not mix them with personal accounts. LLC members must also record minutes of meetings and keep finances apart from those of the owners.
LLCs involve a more significant upfront cost to set the business up, which might be more than that of corporations. In contrast, sole proprietorships and partnerships do not entail any initial setup fees. It’s essential to consider this upfront cost if you’re planning to form an LLC.
Are you thinking about how you can get an LLC? Forming an LLC is a process that involves a lot of legal paperwork that needs to be done right.
We’ve summarised the process here but strongly recommend that you consult a legal practitioner or lawyer before attempting to go through the process by yourself:
Most LLCs are registered in the state where there are located. However, if you plan on doing business in multiple states, then you have the option to choose which jurisdiction you’d like to register in.
This is a defining moment for your new business! That's why you should choose a name that is memorable and impactful.
Most states have a restriction on using the same name as another establishment in the state. Every state’s naming rules are different, so you should go through them on the website of the agency in charge of business filings. You may choose to reserve your name for a period until you’re ready to form an LLC.
When forming an LLC, it’s crucial to choose a registered or statutory agent who receives notices of lawsuits as well as any other legal correspondence concerning the LLC.
You should find out the prerequisites for your state before appointing an agent. However, in most states, the criteria are as follows:
- Is above the age of 18
- Has an address in the state where they can accept documents
Every LLC must furnish an operating agreement. This legal document describes how the business will be managed and how profits will be shared among members.
It must also prescribe procedures for the onboarding of new members and delisting of former members who choose to leave. Remember: if there is no provision for this in the operating agreement and a member leaves, you may have to dissolve the LLC according to some states.
The Articles of Organization are the most important document in the formation of an LLC. The form for the articles of organizations can be obtained from your state business filing authority’s website. Generally, the articles of organization contain the following information:
- Name of the LLC
- Duration of the LLC
- Purpose of the LLC
- Name and address of the statutory agent
- The management structure of LLC
Finally, the Articles of Organization can be signed either by the person forming the entity and the registered agent in some cases, as per state jurisdiction.
Some states ask you to publish a notice in a newspaper to make it known to the public that you intend to form an LLC. Check your state’s requirements to be sure if this applies to you.
Attempting to form an LLC yourself might jeopardize your business several years down the line once it grows. That's why it's best to consult a lawyer who can help explain the procedures to you and look into the state-specific terms and conditions.
Also, if you find managing your books particularly tedious, especially when you'd rather be focusing on scaling your business, consider partnering with Fincent's expert bookkeeping services.
Fincent: Your Business's Personal Financial Wizard - From Bookkeeping to Tax Filing