Business

How to Start an LLC and Protect Your Business

What is an LLC and How Can It Save You Money?

If you’re thinking of starting a business, you might be wondering what type of legal structure is best for you.

Should you go solo as a sole proprietorship, team up with a partner, or incorporate as a corporation?

There’s another option that you might not have considered: forming a limited liability company, or LLC.

An LLC is a hybrid entity that combines the benefits of a corporation and a partnership, while avoiding some of their drawbacks.

In this article, you’ll learn what an LLC is, why you might want to form one, and how to do it in a few simple steps.

You’ll also discover some of the advantages and disadvantages of an LLC, and how to choose the best taxation option for your business.

What is an LLC?

An LLC is a legal business entity that protects its owners, called members, from personal liability for the debts and obligations of the business.

This means that if the business gets sued or goes bankrupt, the members’ personal assets, such as their homes, cars, or bank accounts, are not at risk.

An LLC is also a flexible entity that can have one or more members, who can be individuals, corporations, or other entities. An LLC can be managed by its members, or by one or more managers appointed by the members.

Unlike a corporation, an LLC does not have to follow strict rules and regulations, such as holding annual meetings, keeping minutes, or issuing shares.

An LLC can also choose how it wants to be taxed by the IRS, as we’ll see later.

Why form an LLC?

There are many reasons why you might want to form an LLC for your business.

Here are some of the main ones:

1. Limited liability protection

As we mentioned, an LLC shields its members from personal liability for the business’s debts and obligations.

This can give you peace of mind and protect your personal assets from creditors, lawsuits, or other claims.

2. Tax flexibility

An LLC can choose how it wants to be taxed by the IRS.

By default, an LLC is taxed as a pass-through entity, meaning that the profits and losses of the business are passed through to the members, who report them on their personal tax returns.

This way, the LLC avoids double taxation, which is when a corporation pays taxes on its profits, and then its shareholders pay taxes on their dividends.

However, an LLC can also elect to be taxed as a corporation, either as a C-corp or an S-corp, depending on its needs and preferences. We’ll explain more about these options later.

3. Management flexibility

An LLC can decide how it wants to be managed, either by its members or by appointed managers.

This gives the members more control and autonomy over the business operations, and allows them to adapt to changing circumstances and needs.

4. Ease of formation and operation

Forming an LLC is relatively easy and inexpensive, compared to forming a corporation.

You don’t need to file complex documents, pay high fees, or comply with strict regulations. You just need to file a simple document called the articles of organization with your state, and pay a nominal filing fee.

You may also need to create an operating agreement, which is a document that outlines the rules and responsibilities of the members and managers of the LLC.

Operating an LLC is also simpler than operating a corporation, as you don’t need to keep records of meetings, minutes, or shares.

How to form an LLC?

Forming an LLC is not difficult, but it does require some planning and preparation.

Here are the basic steps you need to follow:

1. Choose a name for your LLC

The first step is to choose a name for your LLC that is unique, catchy, and descriptive of your business.

You also need to make sure that the name complies with your state’s rules and regulations, and that it is not already taken by another business.

You can check the availability of your desired name by searching the database of your state’s secretary of state or business filing agency.

You may also need to add the words “Limited Liability Company” or the abbreviation “LLC” to your name, depending on your state’s requirements.

2. File the articles of organization

The next step is to file the articles of organization with your state.

This is the document that officially creates your LLC and registers it with the state.

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The articles of organization typically include information such as the name, address, and purpose of your LLC, the names and addresses of the members and managers, the duration of the LLC, and the registered agent of the LLC.

The registered agent is the person or entity that is authorized to receive legal documents and notices on behalf of the LLC.

You can file the articles of organization online, by mail, or in person, depending on your state’s options. You also need to pay a filing fee, which varies by state, but usually ranges from $50 to $500.

3. Create an operating agreement

The operating agreement is the document that defines the rules and responsibilities of the members and managers of the LLC.

It covers topics such as the ownership structure, the voting rights, the profit and loss distribution, the capital contributions, the management structure, the meeting procedures, the dissolution process, and the dispute resolution mechanism.

The operating agreement is not required by law in most states, but it is highly recommended, as it can help prevent conflicts and misunderstandings among the members and managers, and protect the LLC’s limited liability status.

You can create your own operating agreement, or use a template or a service that can help you draft one.

4. Obtain an Employer Identification Number (EIN)

An EIN is a nine-digit number that is assigned by the IRS to identify your business for tax purposes.

You need an EIN if you want to open a bank account, hire employees, or file taxes for your LLC. You can apply for an EIN online, by mail, or by phone, for free, on the IRS website.

5. Choose a taxation option

As we mentioned, an LLC can choose how it wants to be taxed by the IRS.

By default, an LLC is taxed as a pass-through entity, meaning that the profits and losses of the business are passed through to the members, who report them on their personal tax returns.

This way, the LLC avoids double taxation, which is when a corporation pays taxes on its profits, and then its shareholders pay taxes on their dividends.

However, an LLC can also elect to be taxed as a corporation, either as a C-corp or an S-corp, depending on its needs and preferences. A C-corp is a separate entity that pays taxes on its profits, and then its shareholders pay taxes on their dividends.

This can result in double taxation, but it can also provide some benefits, such as the ability to retain earnings, deduct expenses, and offer fringe benefits to employees.

An S-corp is a pass-through entity that does not pay taxes on its profits, but each shareholder pays personal income tax on their share of the company’s profits.

This can avoid double taxation, but it can also impose some limitations, such as the number and type of shareholders, the allocation of profits and losses, and the accounting methods.

To elect to be taxed as a corporation, an LLC must file a form with the IRS, either Form 8832 for a C-corp, or Form 2553 for an S-corp.

What are the advantages and disadvantages of an LLC?

An LLC is a popular and versatile business structure, but it is not perfect.

It has some advantages and disadvantages that you should consider before forming one.

Here are some of the main ones:

Advantages of an LLC

  • Limited liability protection: As we mentioned, an LLC protects its members from personal liability for the debts and obligations of the business. This can give you peace of mind and protect your personal assets from creditors, lawsuits, or other claims.
  • Tax flexibility: An LLC can choose how it wants to be taxed by the IRS, either as a pass-through entity, a C-corp, or an S-corp, depending on its needs and preferences. This can allow you to optimize your tax situation and save money on taxes.
  • Management flexibility: An LLC can decide how it wants to be managed, either by its members or by appointed managers. This gives the members more control and autonomy over the business operations, and allows them to adapt to changing circumstances and needs.
  • Ease of formation and operation: Forming and operating an LLC is relatively easy and inexpensive, compared to forming and operating a corporation. You don’t need to file complex documents, pay high fees, or comply with strict regulations. You just need to file a simple document with your state, and create an operating agreement.

Disadvantages of an LLC

  • Limited life span: An LLC may have a limited life span, depending on the state and the operating agreement. Some states require an LLC to specify a dissolution date in the articles of organization, while others allow an LLC to have a perpetual existence. However, even if the state allows an LLC to have a perpetual existence, the operating agreement may provide for a dissolution date, or for events that trigger the dissolution of the LLC, such as the death, withdrawal, or bankruptcy of a member. This can create uncertainty and instability for the business and its members.
  • Self-employment taxes: Members of an LLC who work in the business are considered self-employed and must pay self-employment taxes on their share of the profits. Self-employment taxes consist of Medicare and Social Security taxes, and are usually higher than the payroll taxes paid by employees. This can reduce the net income of the members and increase their tax burden.
  • Lack of uniformity: LLCs are regulated by state laws, and the laws vary from state to state. This can create confusion and inconsistency for LLCs that operate in multiple states, and require them to comply with different rules and regulations.
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How to choose the best taxation option for your LLC?

One of the most important decisions you need to make when forming an LLC is how you want to be taxed by the IRS.

As we mentioned, an LLC can choose to be taxed as a pass-through entity, a C-corp, or an S-corp, depending on its needs and preferences.

Each option has its pros and cons, and you should consult a tax professional before making a final choice.

However, here are some general guidelines to help you decide:

  • Choose pass-through taxation if: You want to avoid double taxation, you have a relatively low income, you want to deduct losses from your personal tax return, you don’t plan to retain earnings or reinvest in the business, you don’t need to offer fringe benefits to employees, and you don’t mind paying self-employment taxes.
  • Choose C-corp taxation if: You want to separate your personal and business finances, you have a relatively high income, you want to retain earnings or reinvest in the business, you want to offer fringe benefits to employees, you don’t mind paying double taxation, and you can take advantage of deductions and credits.
  • Choose S-corp taxation if: You want to avoid double taxation, you have a relatively high income, you want to reduce your self-employment taxes, you don’t need to retain earnings or reinvest in the business, you can meet the eligibility requirements, and you can follow the rules and regulations.

Conclusion

An LLC is a great option for many entrepreneurs who want to start a business with limited liability protection, tax flexibility, management flexibility, and ease of formation and operation.

However, an LLC is not a one-size-fits-all solution, and it has some drawbacks and limitations that you should be aware of.

Before forming an LLC, you should do your research, weigh the pros and cons, and consult a legal and tax professional to make sure that an LLC is the best fit for your business goals and needs.


FAQs

1. What is the difference between an LLC and a corporation?

An LLC and a corporation are both types of business entities that offer limited liability protection to their owners.

However, they differ in several aspects, such as:

  • Taxation: An LLC can choose how it wants to be taxed by the IRS, either as a pass-through entity, a C-corp, or an S-corp, depending on its needs and preferences. A corporation is either taxed as a C-corp, which pays taxes on its profits and then its shareholders pay taxes on their dividends, or as an S-corp, which passes through its profits and losses to its shareholders, who report them on their personal tax returns.
  • Management: An LLC can decide how it wants to be managed, either by its members or by appointed managers. A corporation is managed by a board of directors, who are elected by the shareholders, and by officers, who are appointed by the board.
  • Ownership: An LLC’s owners are called members, who own a percentage of the business. A corporation’s owners are called shareholders, who own shares of stock in the business. Shares in a corporation are easier to transfer than ownership interests in an LLC.
  • Formation and operation: Forming and operating an LLC is relatively easy and inexpensive, compared to forming and operating a corporation. An LLC only needs to file a simple document called the articles of organization with the state, and create an operating agreement. A corporation needs to file more complex documents, such as the articles of incorporation and the bylaws, and comply with more rules and regulations, such as holding annual meetings and keeping records.

2. What is the difference between an LLC and a sole proprietorship?

The main difference between an LLC and a sole proprietorship is that an LLC is a separate legal entity that protects its owners from personal liability, while a sole proprietorship is not.

This means that if an LLC gets sued or goes bankrupt, the owners’ personal assets are not at risk, but if a sole proprietorship faces the same situation, the owner’s personal assets are exposed.

Another difference is that an LLC can choose how it wants to be taxed by the IRS, while a sole proprietorship is always taxed as a pass-through entity.

3. How much does it cost to form an LLC?

The cost to form an LLC varies depending on the state where you register your business, the filing fees, the operating agreement, the publication, the DBA fees, the registered agent, the business license fees, and the annual report fees.

The total startup costs range from $150 to $4,000+, with an average of $3,000+. The maintenance costs are also variable and depend on the state and the services you use.

If you want to save money and time, you can use an LLC filing service that can handle the paperwork and the legal requirements for you.

There are several service providers that can register your LLC for less than $50 plus the state fee. You can also consult a tax professional to help you choose the best taxation option for your LLC.

4. How long does it take to form an LLC?

The time it takes to form an LLC depends on the state where you register your business and the method you use to file the paperwork.

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The average time is 7-10 business days, but some states can issue approval in as little as one day, while others can take up to six weeks.

You can speed up the process by filing online, using an LLC filing service, or paying an expedited fee, if available. You can also check the status of your filing online, by phone, or by mail, depending on your state’s options.

5. Can I convert my existing business into an LLC?

Yes, you can convert your existing business into an LLC, depending on the type of business you have and the state where you operate.

There are different methods and procedures for converting a sole proprietorship, a partnership, or a corporation into an LLC.

Some states allow a streamlined process called a statutory conversion, which involves filing a plan of conversion and a certificate of conversion with the state.

Other states require a more complex process called a nonstatutory conversion, which involves forming a new LLC, transferring the assets and liabilities of the existing business to the new LLC, and dissolving the existing business.

You should consult a legal and tax professional before making a decision, as there may be tax consequences and legal implications for changing your business entity.

6. What are some examples of businesses that use LLC?

An LLC is a type of business entity that offers limited liability protection and tax flexibility to its owners.

Many well-known companies in the US have chosen to form an LLC, such as:

  • Alphabet: The parent company of Google and other subsidiaries, such as YouTube, Waymo, and Fitbit.
  • PepsiCo: The multinational food and beverage corporation that owns brands like Pepsi, Frito-Lay, Quaker, and Gatorade.
  • Sony: The Japanese electronics and entertainment giant that produces products like PlayStation, Xperia, and Bravia.
  • Nike: The world’s largest sports apparel and footwear company that sponsors athletes like LeBron James, Serena Williams, and Cristiano Ronaldo.
  • Hertz: The car rental company that operates in 150 countries and offers services like Hertz Gold Plus Rewards and Hertz NeverLost.
  • eBay: The online marketplace that connects buyers and sellers of various goods and services, such as electronics, fashion, and collectibles.

7. Can I have more than one LLC?

Yes, you can have more than one LLC, depending on your business needs and preferences.

There are different reasons why you might want to form multiple LLCs, such as:

  • To separate different businesses or ventures and minimize your risk if one of them fails.
  • To launch a new product or service and protect the rest of your company from potential liability.
  • To invest in other businesses or projects as a partial owner or partner.
  • To own multiple rental properties and limit your exposure to lawsuits or claims.

However, having multiple LLCs also means more paperwork, fees, taxes, and complexity.

You need to file a separate document and pay a filing fee for each LLC you form. You also need to create an operating agreement and keep records for each LLC.

You may also need to set up DBAs (doing business as) for different businesses under the same LLC. Additionally, you need to choose a taxation option and file tax returns for each LLC.

Therefore, before you decide to form multiple LLCs, you should weigh the pros and cons and consult a legal and tax professional.

You can also use an LLC filing service that can help you with the formation and maintenance of your LLCs.

8. Can I change the taxation option later?

Yes, you can change the taxation option for your LLC later, but there are some rules and limitations that you should be aware of.

According to the IRS, you can change your tax classification once every five years, unless you can show a valid business reason for the change.

You also need to file the appropriate form with the IRS, either Form 8832 to change from a pass-through entity to a C-corp, or Form 2553 to change from a pass-through entity to an S-corp, or vice versa.

You should also consider the tax consequences and implications of changing your tax option, as it may affect your income, deductions, credits, and liabilities.

You should consult a tax professional before making a decision, as they can help you evaluate your situation and choose the best option for your LLC.


References:

  • What is an LLC? Limited Liability Company Structure and Benefits Defined – https://www.investopedia.com/terms/l/llc.asp
  • What Is A Limited Liability Company (LLC)? Definition, Pros & Cons – https://www.forbes.com/advisor/business/what-is-an-llc/
  • Limited liability company – Wikipedia – https://en.wikipedia.org/wiki/Limited_liability_company
  • What Is a Limited Liability Company (LLC)? – https://www.thebalancemoney.com/limited-liability-company-101-2951252
  • LLC Vs. Corporation – Forbes – https://www.forbes.com/advisor/business/llc-versus-corporation/
  • LLC vs. Corporation: Comparison – https://www.mycorporation.com/learningcenter/llc-vs-corporation.jsp
  • How are LLCs and Corporations Different? – https://www.marketwatch.com/guides/business/llc-vs-corporation/
  • Corporation – Wikipedia – https://en.wikipedia.org/wiki/Corporation
  • Sole Proprietorship Vs. LLC: Here’s What You Need To Know – https://www.forbes.com/advisor/business/sole-proprietorship-vs-llc/
  • LLC vs. Sole Proprietorship: How to Choose – https://www.nerdwallet.com/article/small-business/llc-vs-sole-proprietorship
  • How Much Does It Cost To Start An LLC? (2024 Guide) – https://www.forbes.com/advisor/business/cost-to-form-llc/
  • How long will it take to create an LLC? – https://www.legalzoom.com/articles/how-long-does-it-take-to-create-an-llc
  • How long does it take form an LLC? – https://www.simplifyllc.com/llc-glossary/how-long-does-it-take-to-get-an-llc/
  • How to change a corporation to an LLC without dissolving the corporation – https://www.legalzoom.com/articles/how-to-change-a-corporation-to-an-llc-without-dissolving-the-corporation
  • How to Convert an Existing Business to an LLC – https://www.smallbizdaily.com/convert-existing-business-llc-2/
  • 7 well-known LLC examples from popular companies – https://www.doola.com/blog/llc-examples/
  • How to Have Multiple Businesses Under One LLC – https://www.wikihow.com/Have-Multiple-Businesses-Under-One-LLC
  • Can I have more than one LLC? – https://www.legalzoom.com/articles/can-i-have-more-than-one-llc
  • How to switch from new tax regime to old tax regime for FY23-24 Read more at: https://economictimes.indiatimes.com/wealth/tax/how-to-switch-from-new-tax-regime-to-old-tax-regime/articleshow/107476349.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst – https://economictimes.indiatimes.com/wealth/tax/how-to-switch-from-new-tax-regime-to-old-tax-regime/articleshow/107476349.cms?from=mdr
  • Can you change tax regime while filing Income Tax Return (ITR)? – https://www.financialexpress.com/money/income-tax-can-you-change-tax-regime-while-filing-income-tax-return-itr-3045107/
  • Can I Redo My Taxes and Should I? – https://turbotax.intuit.com/tax-tips/amend-return/can-i-redo-my-taxes-and-should-i/L9IW7lJWP

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