Those who are starting a business or are interested in starting a new business should know the most popular entity types: corporations and LLCs. Here we will break down LLCs in terms of what an LLC is, how an LLC is formed, the benefits of an LLC, the negatives of an LLC, how an LLC is taxed, and who an LLC is for.
If you’re interested in learning more about corporations instead, please see “What Is A Corporation”.
What is an LLC?
LLC stands for Limited Liability Company. An LLC is a business entity and the most popular type of business entity in the United States. To understand an LLC, first you should understand what a business entity is.
The easiest way to explain creating business entities is to imagine you have created another person. This person, or entity, has its own name, assets, and sets or rights and responsibilities. You, and whatever partners you have, own this entity and control it to ensure it is functioning according to all US laws. As an owner, you are also known as a Member.
LLCs are the most popular because they are generally the easiest to form and maintain. They provide the same liability protections as a Corporation but without the firm structure of a Corporation, but also without all the benefits. We’ll go into more detail further into this article.
How Do I Start an LLC?
To form an LLC, every state has slightly different requirements for how to file. In general, you create and file Articles of Organization. The Article of Organization include:
- Business Name
- Business Address (which can be your own address if you don’t have a dedicated space yet)
- Owner’s Information
- Filer’s Information (often know as the Organizer)
- Purpose of the Business
Once the Articles of Organization are filed and approved by the state, they will deliver an EIN number, which is the equivalent of your business’s social security number. EIN stands for Employer Identification Number. With this EIN number and your Articles of Organization, you can open a business bank account with most banks.
The next two steps in creating an LLC are state dependent. They are publishing your LLC and creating an operating agreement.
Publishing your LLC is an antiquated law that has stuck around in some states. Essentially, you must publish in newspapers for several weeks, announcing the formation of your company. And this is not a cheap process, since print is no longer as easily accessible as it once was. Once the publication is done, you will receive a Certificate of Publication which must be submitted to the state. Here are the exact rules for publication by state:
Arizona requires LLCs to be published in one newspaper for three runs. A run is generally considered to be one week in Arizona.
Nebraska is similar to Arizona in that it requires publication in one newspaper for 3 weeks.
In New York, you must publish in two newspapers for six consecutive weeks.
When it comes to drafting an Operating Agreement, although only five states require a signed Operating Agreement, we can’t stress how important an Operating Agreement is for a business. Every business should have one. Operating Agreements dictate the structure of the LLC, how an LLC will be managed, the membership split between owners, and the rules for both employees and owners. The specific state requirements for Operating Agreements are as follows:
California Operating Agreements have the option to be either oral or written. If written, then the agreement must be signed and stored with the rest of the company documents.
Delaware requires a standard Operating Agreement, but the time limit to draft and sign the Operating Agreement is fairly lax, as long as it is done within a reasonable amount of time
Maine is like Delaware in that it requires an Operating Agreement, but the timeframe to create and sign isn’t a hard deadline. However, in Maine the Operating Agreement can be oral or written.
Missouri is similar to California and Maine, meaning that members have the option of an oral or written Operating Agreement.
New York has the most strict laws when it comes to Operating Agreements, as it requires a written agreement filed in a timely manner.
Once all of this is accomplished, your LLC should be ready to go. There are licenses to consider that you may need to run in specific industries. For more information on this, check at “Business Licenses”.
The Benefits of an LLC (Pros)
LLCs are the most popular entity type for a reason – they offer Limited Liability Protection and pass-through taxation.
Limited Liability Protection is the concept that your business is a separate entity from yourself. This means that the business owns assets and has responsibilities of its own. So should your LLC build up debt or get sued, the collector can’t pursue your personal assets. So your home, money, cars, or any other valuable possessions are protected by your business.
There are exceptions to Limited Liability (also known as the Corporate Veil) which include gross negligence by the members, unfulfilled state requirements, and certain personal involvement. All of these may be reasons that the Corporate Veil could be pierced and your personal assets could be at stake. These are very rare cases, so if you are following all rules and regulations, your company and its Liability Protection should be intact. To learn more about this, we recommend calling our office. Contact us here.
When it comes to pass-through taxation, we will go into more detail in the tax section. To be very brief, pass-through taxation is when the business doesn’t pay taxes, only the owners pay taxes on the profits they receive from the business. This is the same way Sole Proprietorships and Partnerships are taxed, which is always a big concern for those nervous about taking the jump from Sole Proprietor to LLC.
Additionally, LLCs secure a business name on a state level, meaning no other business in that state can have that exact name. Sole Proprietorships and Partnerships technically operate under the name of the owner or owners.
The Negatives of an LLC (Cons)
Although LLCs fit the bill of what most businesses are looking for, they aren’t built for certain industries or business goals. LLCs can’t be publicly traded, have more issues transferring ownership, and they aren’t built for large scale growth.
When it comes to issuing shares and investing, C-Corporations are best suited for that. LLCs can’t be publicly traded and issuing membership shares is much more difficult, which is why investors typically won’t invest in LLCs. And as Corporations grow, they have a structure that is built with checks and balances such as a Board of Directors and Corporate Officers. LLCs require more work to be scaled properly.
How is an LLC Taxed?
As previously mentioned, LLCs have pass-through taxation. This means that all profits, losses, and taxes are given right to the owners. The LLC itself does not pay any taxes and the owners are just taxed on any profits they receive from the LLC. This is a huge benefit of an LLC since it doesn’t require a separate tax filing, as with a Corporation. We would still recommend having a bookkeeper or accountant on hand to help with managing finances and answering more specific tax questions.
Who is an LLC for?
LLCs are for almost everyone. An LLC offers benefits that appeal to different people for different reasons, such as pass-through taxation, minimal upkeep, or Limited Liability Protection.
If you want to separate your business assets from your personal assets, an LLC can do that for you. The best example we can give is that people who own rental properties should be putting their property into an LLC. That way, should a tenant sue for any reason, the LLC is being sued instead of the owner. To learn more about this, see “Holding Real Estate In An LLC”.
If you’re looking to pay less taxes, the LLC itself doesn’t pay taxes and instead passes all profits directly to the members. You are taxed as a Sole Proprietorship or Partnership, but with the benefits of an LLC. C-Corporations pay double taxes, once at the business level and once at the personal level.
If you would like a business but don’t want the upkeep and regulation of a Corporation, then an LLC is for you. Corporations have to establish a Board of Directors, assign Corporate Officers, hold Annual Meetings, and keep Corporate Minutes by law. LLCs don’t require any of that, and if it’s just you in the business, you answer to no one but yourself.
In summation, LLCs are great for first-time businesses, small businesses, rental properties, and everything in between. The only entrepreneurs who shouldn’t be starting an LLC are those that are looking to go public soon, companies owned by foreigners, companies that do a large share of their business internationally, and tech businesses.
If you have any questions at all you can call our office directly at 212-256-1877 or you can schedule your free call by visiting our contact us page.