When choosing a business structure, it’s important to think about personal liability. If you don’t have an LLC (Limited Liability Company), business debts and legal problems could jeopardize your personal assets like your home or savings. To reduce this risk, it’s essential to understand how to form an LLC, as it provides valuable protection by limiting your liability.
This article breaks down the basics of an LLC, explaining what it is and how it works. It will guide you through the steps to start an LLC and introduce you to the various types available. Understanding these aspects is essential for anyone considering different business options.
What is an LLC?
An LLC is a special type of business that combines protection of your personal assets, like a corporation, with the simplicity and flexibility of a partnership. Think of it as a mix of both. This structure ensures that the owners, called members, are protected from liabilities. Also, it allows profits and losses to be directly passed on to them without corporate taxes.
Here are its features to understand it better:
- Limited liability protection. Members are not personally liable for the company’s debts and liabilities. This means their personal assets, like homes and savings accounts, are protected from business debts. Legal actions against the business also can’t touch their personal assets.
- Flexibility in management and operations. Unlike corporations, which require a board of directors and officers, an LLC offers more flexibility in how it’s managed and operated. It can be managed by its members or a designated manager.
- Pass-through taxation. By default, LLCs are not taxed directly at the business level. Instead, income or losses are “passed through” to the individual members. They report them on their personal income tax returns. This avoids the double taxation often associated with corporations.
- Ease of formation and maintenance. Creating an LLC is generally simpler. It requires less paperwork and formalities than forming a corporation. It also tends to have fewer ongoing requirements, which makes it a popular choice for small businesses and startups.
- Ownership flexibility. An LLC can have one or multiple members, and there’s no limit on the number of members. Members can include individuals, corporations, other LLCs, and foreign entities.
Why small businesses choose LLCs
This structure is particularly appealing for its ability to protect personal assets from business liabilities. Sole proprietorships and partnerships typically do not offer this safety net. This means that in legal disputes or debts, the personal assets of the business owner, like their home or personal savings, are safe.
Also, LLCs offer scalability. This makes them ideal for businesses in different growth stages. For solo entrepreneurs, an LLC provides a formal business structure. It avoids the grueling requirements of a corporation, such as board meetings or shareholder agreements. As the business grows, adding members to an LLC is easy because there’s no limit to how many members it should have. This makes it effortless for LLCs to transition from a single-member to a multi-member LLC.
LLCs provide tax advantages for small businesses. One important benefit is that they use pass-through taxation. This means that business income is only taxed once at the personal tax rate of the members. This eliminates the double taxation that corporations commonly face. Additionally, LLCs offer tax flexibility, where businesses can choose to be taxed as a corporation if it benefits them.
The operational flexibility of an LLC is also a significant draw. Unlike corporations, which are often bound by rigid operational structures, LLCs enjoy the freedom to structure their management and operations as they see fit. This allows small business owners to tailor the company’s operational model to their specific business needs and management style.
LLCs offer legal protection, scalability, tax benefits, and operational flexibility. These features make LLCs a versatile and practical choice for you. They provide the necessary legal framework to operate efficiently and securely. This ultimately gives you the confidence to focus on growing your business.
Steps to starting an LLC
Starting a Limited Liability Company (LLC) involves these several crucial steps:
Step 1. Choose a business name
Make sure your LLC’s name stands out and isn’t easily confused with other businesses. Each state has its own guidelines regarding business names, including prohibitions on certain words and requirements for the inclusion of “LLC” or similar designations. It’s important that you conduct a thorough search to ensure your chosen name isn’t already in use or very similar to an existing business. This is usually available on your state’s business filing agency website.
Step 2. Select a registered agent
A registered agent is a person or entity designated to receive official legal and tax documents on behalf of your LLC. This agent must be authorized to conduct business in your state and must have a physical address within the state. Further, the registered agent is crucial for ensuring compliance. They also take care of important documents, such as lawsuit notices or state filings, professionally and promptly.
In addition to the things mentioned above, you should consider these criteria for choosing the right registered agent:
- Availability. The registered agent must be available during standard business hours to receive important legal documents. Consistent availability ensures that no important communications are missed.
- Experience and reliability. Look for an agent with a proven track record of reliability. Also, look for an agent with experience in handling legal documents. Their ability to manage paperwork efficiently is vital. They’ll also notify you promptly of any important documents received.
- Privacy and confidentiality. Registered agents handle sensitive information. They should be trustworthy and committed to maintaining confidentiality.
- Organizational skills. An effective registered agent should be organized. They should be able to manage and keep track of various legal documents and deadlines.
- Professionalism. Choose an agent who maintains a high level of professionalism. They will be a direct point of contact with a state agency on your behalf.
- Additional services. Some registered agents offer additional services like compliance alerts. They also help with filing annual reports, or even assist with legal and tax notices. Depending on your needs, these extra services can be beneficial.
- Cost. Evaluate the cost of their services against the benefits they provide. Consider affordability. However, remember that the cheapest option may not have the best service quality.
- Reputation. Check reviews or ask for referrals to know the reputation of the registered agent. A good reputation is an indicator of quality service.
- National coverage. If you plan to operate your LLC in multiple states, consider an agent with a national presence. They can provide registered agent services in all states where you operate.
Step 3. File the articles of organization
Creating a formal document to set up your LLC is crucial for officially establishing your business. In this important paperwork, you’ll need to share basic information about your LLC, like its name, address, and who the members are. Some states might ask for extra details, like the purpose of your business or information about the person representing your company (registered agent).
Once you’ve gathered all the necessary information, you submit this document to the state’s business filing agency. Keep in mind that there’s usually a fee involved. Many states make it easy by allowing you to do this online, but some might still prefer or require you to send it in by mail.
Step 4. Create an LLC operating agreement
Although not always legally required, having an operating agreement is highly recommended for LLCs. This document outlines the management structure and operational guidelines the LLC has to follow.
This internal document can cover various aspects. For example, it may include the distribution of profits and losses, member responsibilities, and procedures for adding or removing members. It acts as a guidebook for running your LLC. It can be vital in settling disputes or misunderstandings.
These are the components that an operating agreement typically includes:
- LLC name and principal place of business. The official name of the LLC is as registered in the state. It is the primary location where the business operates.
- Duration of the LLC. Some LLCs are established to exist perpetually, while others have a specified end date.
- Purpose of the LLC. A brief description of the business activities the LLC will engage in.
- Member information. Details of the LLC’s members, including their names and addresses.
- Ownership structure. How ownership is divided among the members, usually expressed in percentages or units.
- Capital contributions. The amount of money, property, services, or other assets each member has contributed to the LLC.
- Profit and loss distribution. How profits and losses will be distributed among the members. This could be based on the percentage of ownership or another method that’s agreed upon.
- Management structure. Specify whether the LLC will be member-managed or manager-managed. Include details about how management decisions will be made.
- Voting rights and responsibilities. How your LLC conducts voting for business decisions. This includes what constitutes a quorum (or the minimum attendees in a meeting) and the percentage of votes needed to approve different types of decisions.
- Meetings and record-keeping. Guidelines for holding meetings, including annual meetings, and requirements for record-keeping.
- Rules for adding or removing members. Procedures for bringing in new members, transferring ownership shares, or handling the exit of existing members.
- Dissolution terms. Conditions under which the LLC might be dissolved and the process for settling business affairs.
- Amendment process. The procedure for making changes to the Operating Agreement.
- Buy-sell/succession rules. These guidelines explain what happens if a member wants to sell their interest. These also cover what happens if a member becomes incapacitated or dies.
- Dispute resolution. Procedures for resolving internal disputes among members or with the management.
- Signatures. The Operating Agreement must be signed by all members to be in effect.
Step 5. Obtain an EIN
The Employer Identification Number (EIN), often called a Federal Tax Identification Number, is essential for various business functions. It’s required for tasks such as hiring employees, opening business bank accounts, and paying federal taxes. Luckily, obtaining an EIN is a free service provided by the IRS. You can quickly do it online through the IRS website, and options for mail or fax applications are also available.
Follow these steps to apply for an EIN:
Step 1: Determine eligibility
- Ensure that your principal business is in the United States or U.S. Territories.
- The person applying must have a valid Taxpayer Identification Number (SSN, ITIN, EIN).
Step 2: Visit the IRS Website
- Go to the IRS EIN online application page.
- The EIN online application is available Monday through Friday, 7 a.m. to 10 p.m. Eastern Time.
Step 3: Begin the application
- Review the guidelines provided by the IRS before beginning.
- Select “Apply Online Now” to start the application process.
Step 4: Fill out the application
- Follow the prompts and provide the required information, including:
- The type of EIN you are applying for (Individual/Sole Proprietor, Corporation, Partnership, Trust, Estate, etc.)
- Personal and business information such as name, Social Security Number, address, and type of business
Step 5: Submit the application
- After filling out the necessary information, review your application for accuracy.
- Submit your application. You should stay on the page and avoid refreshing to prevent application errors.
Step 6: Receive your EIN
- Once submitted, the application will be processed. An EIN will be issued immediately.
- You can then download, save, and print your EIN confirmation notice.
Alternative application methods
- Fax: Complete Form SS-4 and fax it to the appropriate fax number (you can find this on the IRS website).
- Mail: Mail the completed Form SS-4 to the appropriate address (this also can be found on the IRS website).
- Note: Fax and mail applications take significantly longer than the online process.
- The individual applying must be the owner or a responsible party of the business.
- EIN applications are limited to one per responsible party per day.
- The online application process is the fastest way to receive your EIN.
After the processes above, you can proceed to create your website. This establishes your online presence. It helps your small business be found by potential customers.
5 different types of LLCs
Learn about the different types of LLCs and find out what they’re ideal for.
Single-Member LLC (SMLLC)
Ideal for individual entrepreneurs, the Single-Member LLC offers the simplicity of a sole proprietorship and the liability protection of a corporation. It’s perfect for solo business owners who want to keep their personal and business finances separate. Not only are they easier to set up and maintain compared to more complex LLC structures, but they are also a popular choice for freelancers, consultants, and individual proprietors.
Multi-Member LLCs are suitable for businesses owned by two or more individuals. They work similarly to partnerships but with the benefit of limited liability protection. Ideal for joint ventures or partnerships, these LLCs help owners clearly define their roles, responsibilities, and how profits or losses are shared within a formal business entity.
A Series LLC is a unique form of an LLC that allows multiple ‘series’ or ‘cells’ within a single LLC structure. Each series can own separate assets, liabilities, and members and managers. This structure benefits companies that manage several properties or projects, as it allows them to isolate risks and liabilities in separate divisions without creating a new legal entity for each venture.
Professional LLC (PLLC)
PLLCs are perfect for licensed professionals like doctors, lawyers, accountants, and architects. These are ideal in industries where a state license is required to provide professional services. PLLCs offer the same advantages as regular LLCs. However, they often come with specific requirements and restrictions based on state laws pertaining to professional services. Lastly, PLLCs provide a way for these professionals to enjoy liability protection while still adhering to the ethical and legal standards of their profession.
Low-Profit LLC (L3C)
The Low-Profit LLCs, or L3Cs, have both the simplicity of running a regular business and a non-profit’s social goals. These qualities are what makes it attractive for both private investments and philanthropic funding. Unlike typical businesses that aim for maximum profit, L3Cs focus on achieving a social or environmental objective.
This type of LLC is commonly found in areas such as education, healthcare, and sustainability. The hybrid nature of this LLC allows you to pursue a social mission while making money and ensuring financial stability at the same time.
Begin your entrepreneurial journey now
Starting an LLC involves some key steps that set up a flexible and protective business structure. Whether you go for a single-member or multi-member LLC, the options cater to different needs. Small businesses opt for an LLC because it’s easy to manage, offers tax flexibility, and provides a crucial layer of limited liability. This means your personal assets stay safe, giving you peace of mind as you navigate the challenges of running a business.
By following our step-by-step guide, you can confidently set up your LLC and make your business thrive.