What is an LLC?
A limited liability company is a relatively new business structure that exists at the state level. It’s a bit of a hybrid structure, that combines the ease of running a sole proprietorship with the protections of a corporation. It’s not hard to learn how to form an LLC and most business owners who choose to form LLCs do so for at least one of the following reasons:
- Protection. An LLC offers its owner(s) liability protection, so that as an owner, you don’t have to worry about someone coming along and suing you for the things your LLC did or didn’t do.
- Single taxation. An LLC has what’s called “flow-through” taxation, so LLCs don’t pay the double tax corporations pay. I mentioned in the corporations article that corporations must pay income taxes on their profits IN ADDITION to its owners paying personal income taxes on the wages or dividends they received from the corporation. When you own an LLC, there is no corporate income tax to pay. Instead, the profits and earnings flow through the LLC and that income is reported on the individual tax returns of the company’s owners.
- Simplicity. While your state will require you to file an annual report for your company, running an LLC doesn’t require the same level of record keeping and reporting as running a corporation. Simplicity is usually a pretty strong selling point when you’re dealing with small business owners.
How to Form an LLC
Limited liability companies are formed at the state level. For a modest fee (ranging anywhere from $50 to a few hundred dollars), you can complete and submit the Articles of Organization to the Secretary of State where you live. You can usually do this right online or by fax and get a decision from your state in hours or days.
Owners of an LLC are called members; members can be individuals, organizations or other companies. An LLC can have hundreds of members or it can have one – you. States will typically require the following information from you when you file your articles of organization:
- The name of your limited liability company. Your company will need a name that is unique within your state. You can usually conduct a quick name search right online using an entity search function on your state’s Secretary of State website. This will help you to quickly determine if someone else is actively doing business in your state using your proposed company name. Once you choose your name, you legally must include one of the following suffixes at the end of your chosen business name: LLC, LC, Limited, or Ltd.
- The legal names and addresses of the members. States require you to submit physical addresses (not PO Boxes) for each person or company involved in organizing the business.
- A brief description of the type of business in which your corporation will be engaged. Most states provide fill-in forms that only require you to submit basic information, so you probably won’t have to provide heaps of info about your day-to-day activities. In fact, your state has probably already filled this section out, or at the very least provided the verbiage in the instructions for you to write in.
- The name and address of the company’s registered agent. The State wants to know who your company’s go-to person is. That person or business is called the Registered Agent (RA). The most important job your Registered Agent has is making sure the decision makers receive (and remit) correspondence, forms, documentation and tax information from the State Monday through Friday from 8AM to 6PM. The RA is also the person to whom the courts will send Service of Process for a summons in the event your corporation is involved in a lawsuit. Your RA has to be in the same state of your LLC and must have a physical address.
LLCs at the Federal Level
At the federal level, LLCs don’t actually exist as a separate tax designation. They are recognized as a legal business structure, but there are no specific tax rules that are just for an LLC. When you form your LLC, your company will, by default, be taxed as if it was a sole proprietorship (or a general partnership if there is more than one owner-member). You will complete a Form 1040 and include Schedules C (sole prop) or Schedule E (partnership) to report business income. Yes, it is possible to operate an LLC and have employees. If your LLC has employees, you will be responsible for filing Form 941 Employer’s Quarterly Federal Tax Return.
You have the option to have your LLC taxed like a corporation and can complete and submit Form 8832, Entity Classification Election, to elect how it will be classified for federal tax purposes.
According to the IRS, “The profit of a corporation is taxed to the corporation when earned, and then is taxed to the shareholders when distributed.” This double-whammy when it comes to paying taxes (being taxed at the corporate level AND the individual level – is what often makes SMEs choose to form LLCs instead of corporations.) Corporations can’t deduct the money they pay out to shareholders and shareholders can deduct any loss of the corporation.
I encourage you to read more about IRS tax rules for your LLC here.
Is an LLC the Right Business Structure for Your Company?
Now that you know and hopefully understand the basics, let’s talk about how this information impacts you by reviewing the a few of the key issues small business owners use to decide whether an LLC is the right business structure for their companies.
Liability protection. LLCs offer you liability protection. Limited Liability Companies protect their owners against liabilities incurred by the company in most cases. As such, individual owner-members cannot be held liable for the debts, responsibilities and actions of the LLC. That means if someone sues your company, they cannot take your personal assets to cover the judgment if the company doesn’t have the cash or assets to pay.
Flow-Through taxation. While you have the option to elect to have your LLC taxed at the corporate level like a corporation, by default, the IRS will tax your LLC just as it would a sole proprietorship or general partnership. There is no corporate-level income tax. As a business owner, you will pay income taxes on the money you receive from your LLC in the form of dividends and wages.
Independence. An LLC can act independently from its owners and exist long after its owner(s) has left the company.
I’m going to stop here and allow you the chance to ruminate on what we know so far. Don’t be shy about doing more research and asking plenty of questions.