How to Form an LLCAre you wondering how to form a company? If so, you may find yourself sitting in confusion wondering where to even begin. Do I need a lawyer? How much money do I need in order to start? What type of business structure works best for my product or services? These are just a few of the dozens of questions you need to consider before opening up shop. To get you started, we’re going to go over one of the most popular business structures entrepreneurs turn toward when creating a business—a limited liability company, or LLC. If you’re interested in starting a business, keep reading to learn about how to form an LLC, as well as learn more about the advantages and disadvantages about this type of business structure. You can use the links below to jump to different sections, or read from top to bottom for a thorough understanding of LLC’s.
- What is an LLC?
- What are the different types of business structures?
- What are the advantages of an LLC?
- What are the disadvantages of an LLC?
- How do I start my own LLC?
- How do I maintain my LLC?
- Wrapping Up
What is an LLC?A limited liability company, commonly referred to as an LLC, blends two business models together: corporations and sole proprietorships/partnerships. Similar to corporations, an LLC is a completely separate entity from you, the owner. This means you have limited liability, as the name of this business structure alludes to. With limited liability, your personal assets, such as your car, home, and personal savings, are protected if your company faces a lawsuit or bankruptcy. However, unlike a corporation, an LLC isn’t bound by strict rules and has more flexibility when it comes to being managed and taxed—similar to sole proprietorships and partnerships.
What are the different types of business structures?As you may know, an LLC isn’t the only type of business structure you can choose from. Aside from LLCs, owners can choose from other types of business structures, including sole proprietorships, general partnerships, C Corporations, or S Corporations. Below, you’ll find information on how each of these business structures operates, starting with LLCs.
Limited Liability Company (LLC)As we mentioned, an LLC integrates the structural models of both corporations and sole proprietorships/partnerships. They’re unique in that an LLC separates personal assets from business assets, which protects the owner, giving them more freedom and flexibility when it comes to choosing a tax structure and management plan.
- Ownership- LLC owners are called members. There can be single-member LLCs, LLCs owned by other corporations, or multiple members in charge of the LLC. There is no restriction to who can own an LLC, so foreign entities can participate as well.
- Formation- To form an LLC, an LLC Operating Agreement must be filled out, as well as all licenses, permits, and registrations required by the state they’re operating in. Additionally, the name of an LLC must be unique and cannot be in use in the state they are in. You can even form an LLC online using business creation services.
- Taxes- In the eyes of the IRS, an LLC isn’t a separate tax entity, so the business is not taxed. Instead, the federal government considers an LLC as a pass-through entity, requiring members (LLC owners) to pay through their personal income taxes. A benefit of an LLC is that members can choose the tax structure that meets their financial needs. This means they can be taxed as a corporation, partnership, or as part of the LLC’s member’s personal tax returns. Members can fill out IRS Tax Form 8832 to change filing status.
- Examples- YouTube, United States Postal Service, Chrysler are all examples of LLCs.
Sole ProprietorshipIn a sole proprietorship, there is only one owner of the business. This business structure is the easiest structure to create, which can be highlighted by the fact that The Tax Foundation found there are 23 million sole proprietorships in the United States alone. This statistic is compared to the 1.7 million C corporations and 7.4 million partnerships and S corporations in the country. As the sole proprietor, you have lower startup costs and more freedom when it comes to making decisions for your business. However, you are completely liable for any debts or liability issues, which makes your personal assets vulnerable.
- Ownership- As the name says, there is only one sole owner in a sole proprietorship. As the sole owner, there is no distinction between the business and the individual. This means if your business faces bankruptcy or liabilities, your personal assets can be used as collateral and be taken away from you to settle tax and other debts.
- Formation- If you want to be a sole proprietor, all you must do to create a business is to obtain the right licenses, permits, and registrations required by your state. Like all businesses, however, it’s important you have a thorough business plan, enough funds, and small business grants to make a profit and be successful.
- Taxes- When Uncle Sam comes knocking at your door, you have to report your income, losses, and expenses on IRS Schedule C Form 1040.
- Examples- Restaurant owners, repairmen, childcare workers are often structured as sole proprietorship businesses.
General PartnershipA general partnership is similar to a sole proprietorship, however, the big difference is that two or more people share ownership of the company. Each owner is responsible for contributing equal amounts of labor, skill, and financial resources, while sharing the profits and losses of the company. Like a sole proprietor, all partners are responsible for debts and liabilities, leaving their personal assets at stake in case of a lawsuit or bankruptcy.
- Ownership- A general partnership requires an agreement, so there must be a minimum of two partners. Additionally, general partnerships can have as many owners as they want.
- Formation- Forming a general partnership is easy like a sole proprietorship and requires you to obtain the right licenses, permits, and regulations with the state. However, it is more expensive than a sole proprietorship and there is more legal work to complete because there is more than one owner.
- Taxes- When tax time comes around, general partnerships must file IRS Schedule K Form 1065 with the IRS. Each owner is responsible for taking care of their own taxes with their share of profits and losses recorded.
- Examples- Microsoft, Hewlett-Packard, Chanel are all recognizable examples of general partnerships.
C CorporationA corporation, also called a C corporation or C corp, is a legal entity that is completely separate from its owners. Unlike the previous three business structures, C corporations differ in that they can be taxed, and the business is held legally liable for debts, bankruptcy, and any other liabilities. C corporations have the strongest protection for their owners but are much more expensive to create and require extensive recordkeeping and reporting. Additionally, C corporations can make a profit through stocks; unlike partnerships, sole proprietors, and LLCs.
- Ownership- C corporations have the ability to sell shares of the company in the form of a stock, giving shareholders a form of ownership. A corporation can have one shareholder or thousands—Google currently offers 19,605,052 shares in their C corporation. Because C corporations are considered a separate legal entity, shareholders technically aren’t legal owners because they can’t make business decisions.
- Formation- To form a C corporation, you must follow the standard process of applying with the state you’re operating in, and obtain the correct permits, registration, and licenses. C corporations are also required to file Articles of Incorporation with the Secretary of State.
- Taxes- C corporations differ from sole proprietors, general partnerships, and LLCs because they must pay an income tax on their profits. They can also be taxed a second time when dividends are paid to the company’s shareholders on their own personal tax returns. C corporations must file IRS Form 1120 when the time comes to pay taxes.
- Examples- Amazon, Google, ExxonMobil, Boeing are registered C corporations.
S CorporationLast but not least are S corporations. The major advantage of an S corporation is that they can avoid the double taxation that C corporations face. With an S corp, profits and losses can be passed through to the owner’s personal income without having to face corporate tax rates. S corps have the same benefit of having an independent life like C corps and LLCs, leaving owners protected from liability issues such as bankruptcy and lawsuits.
- Ownership- An S corporation is similar to a C corporation in that shareholders are owners, with a Board of Directors making decisions. The only difference is that S corporations can only have a maximum of 100 shareholders, and all must be U.S. citizens.
- Formation- Forming an S corporation is also like forming a C corporation, with registrations, licenses, permits, and Articles of Incorporation being filed with your Secretary of State’s Office. However, S corporations must have all shareholders sign and file IRS Form 2553.
- Taxes- S corporations are beneficial in that they grant shareholders limited liability like C corporations and LLCs, but also allow you to pay income taxes similar to sole proprietorship and partnership business structures.
What are the advantages of an LLC?Now that you know about the different business structures you can choose from, it’s time to delve into the world of Limited Liability Corporations. LLCs are an extremely popular business structure for many people looking to start their own company. They aim to bring together all the benefits of both corporations and sole proprietorships. Here are some of the advantages of forming an LLC:
- Limited Owner Liability– You and your personal assets are protected from damages on your property or by your business, unpaid debts, and vendor disputes. However, circumstances such as fraud, commingling your personal and business funds, and failing to meet LLC requirements are not protected.
- Easy to Form– To create an LLC, choose a state, file complying paperwork, and obtain an EIN from the IRS. You can even form LLCs online or use business formation services to get your LLC started.
- Can Have Unlimited Partners– LLCs allow you to start with either one member or multiple members, depending on your business needs. So, an LLC can be owned by one person, like many small real estate companies are owned. Or, an LLC can be owned by a corporation, such as how Google (a C corporation) owns YouTube (an LLC).
- Tax Flexibility– LLC owners can choose how they want to be taxed, whether as a sole proprietor or as a corporation. The U.S. Government Accountability Office found that of the 26 million businesses in 2014, 95% of those chose the pass-through method of taxation (often used by LLCs, sole proprietorships, S corps, and partnerships), while the remaining 5% were taxed as C corporations.
- Unrestricted Pay– Different members can be paid varying amounts regardless of their share of ownership. This offers better profit-sharing and allows members to receive tax write-offs for business expenses.
What are the disadvantages of an LLC?Creating an LLC has many rewarding advantages that appeal to entrepreneurs. With limited liability, owners can have peace of mind knowing their personal assets are protected in case anything were to happen with their company. However, owning an LLC comes with a few drawbacks. Here are some things to keep in mind when forming an LLC:
- Taxes– While it’s an advantage that you can choose how your LLC will be taxed, either as a sole proprietor, partnership, or corporation, the IRS doesn’t consider you an employee. This means Social Security and Medicare payments are not deducted from your paycheck. Because the IRS doesn’t tax your LLC as a business entity, you must pay a self-employment tax on all LLC profits allocated to you.
- Fees– To start an LLC, you must pay a setup fee, as well as ongoing annual fees to keep your LLC current. Depending on your state, fees can range from $0 all the way up to $800 or more.
- Difficult to Make Profits– LLC’s can’t make revenue from shares, which is unattractive to many outside investors. This makes it difficult to make raise capital because one of the only ways to make sufficient funds is if an outside investor decides to buy-in as a member.
- Uncertain Lifetime– Unlike corporations, if a member leaves your LLC, whether by death, retirement, or pursuing their own interests, the state will require the LLC to dissolve, unless the operating agreement states otherwise. This leaves the company’s members having to handle the debts, finish business requirements, and divide profits and losses before dissolving the LLC. When it’s dissolved, they can decide to create a new LLC with the same members and business, or completely abandon it.
- Limited Benefits- Because LLC’s have limited liability, there are fewer benefits like group health insurance because you are considered self-employed in the eyes of the IRS.
How do I start my own LLC?Finally, time for the fun part! After reviewing the pros and cons of starting an LLC and deciding it’s the right option for you, it’s time to start your own. Whether you want to form an LLC online or use a business formation service, you should follow these steps to get your LLC up and running:
Step 1: Choose a name for your LLCThe first step to starting your LLC is finding a state you plan on operating in, and choosing your business’ name. Typically, most owners choose to start their LLC in the state they’re operating from. However, if you plan to extend your business to multiple states, you’ll have to choose which one you want to form your LLC in. Begin your LLC ventures by choosing the name for your company. Each state may have different requirements, but the general rule is that your LLC can’t have the same name as another LLC registered in your state. You can go to the state agency in charge of business filings, such as your Secretary of State Department, to search LLC names operating in your state to ensure the one you want isn’t taken. Additionally, most states allow you to mail a form with a fee to reserve your anticipated LLC name for a set period of time if you plan on starting an LLC in the future. Lastly, your name can’t be misleading, can’t include words like “bank,” “insurance,” or “city,” and must have LLC or “limited liability company” at the end of your name.
Step 2: Choose a registered agentOnce you have your LLC’s name chosen, it’s time to register your LLC. As you go through the process of registering your LLC, there’s going to be a lot of paperwork, and some states may require more documents than others. This leaves a majority of the states to require a registered agent, or statutory agent, to be appointed to receive all of the legal documents on your LLC’s behalf. The registered agent must be in the state of operation and available during normal business hours to collect legal documents. In most cases, the owner or employee is the registered agent. However, some may choose to hire a registered agent to take care of these matters so they can focus on their business.
Step 3: Hire an attorneyThis step is optional, but hiring an attorney will give you peace of mind that all your legal work is filed correctly. From small business taxes to complying with health, safety, zoning, and other codes, a lawyer will help you along the way. An attorney will also look over your operating agreement (discussed in the step below), and will ensure you and other members are legally complying with the agreed-upon rules.
Step 4: Create an LLC Operating AgreementAn LLC Operating Agreement is a legal document required by most states when starting an LLC. An LLC Operating Agreement defines the ownership and membership duties of your LLC, while also detailing the roles and responsibilities of each member and manager. The U.S. Small Business Administration recommends creating an LLC Operating Agreement to detail the financial and functional decisions of your company. This agreement will outline how and when meetings will take place, how to transfer ownership if a member leaves, and how business decisions will be made. It will also include key pieces of small business accounting, such as how profits and losses will be distributed to each member.
Step 5: Publicly announce your businessThis is an outdated practice, where decades ago the only way people knew about a new business being formed was through their local newspaper. However, some states such as New York and Arizona require you to publicly announce your business in a local newspaper. Often, the county clerk will determine which newspapers to publish in and can sometimes require you to publish up to six weeks in a row. Because a few states still require this process, check with your state’s LLC office or Secretary of State Department to determine whether you need to publicly announce or not.
Step 6: Obtain the right licenses and permitsBefore you open up shop, there are still a few more legal matters that need to be taken care of. Depending on your industry, services, or products, you’ll need to obtain and file pertinent licenses, registrations, and permits in order to operate. Common licenses include a business license, law license, doctor license, food and safety license, zoning permit, or a seller’s permit. You’ll also need to obtain an Employer Identification Number from the IRS in order to legally operate with employees. It’s also required by the IRS to set up a bank account to keep your personal and business cash flows separate. Doing so will allow you to manage your small business payroll, accrue interest in a savings account, and manage your expenses.
How do I maintain my LLC?Hooray! Now you know how to form a company. You’re all done filling out the forms, getting the right permits, drafting an agreement, hiring employees, and everything in between. The last thing you want is for all your hard work to go to waste. After you cut the red ribbon to open your new business, it’s just as important to maintain it and keep your LLC in good standing. To properly maintain your LLC, make sure you:
- Keep detailed financial records
- Record minutes of business meetings and major decisions
- Determine your estimated tax payments
- Pay your taxes on time every year
- Keep your registered agent information up to date