A limited liability company (LLC) is a business structure that’s a hybrid of a corporation and a partnership. It is similar to a corporation in terms of limited personal liability for its owners and is similar to a partnership in terms of tax efficiencies and business flexibility.
In this article, we’ll discuss how to form an LLC, and the different aspects of an LLC to help you decide if it’s the right business structure for you.
How To Form An LLC
LLCs are easier to form than a corporation, but the state filing fees are usually about the same. You must file articles of organization with your state and publish notice of the LLC’s formation in a local newspaper.
Business owners can create an operating agreement which includes percentage of interests, information on profits and losses, key responsibilities, and member’s rights. This is recommended as it provides structure for your finances, and sets out regulations for operations.
As with any business form, you must obtain local permits and register a trade name if you’ll be doing business under a name that is not your official business name. All states now allow single-member LLCs, so a one-person business can form an LLC.
How To Determine If LLC Is The Right Business Structure For Your Business
While LLC offers a lot of advantages, it doesn’t necessarily mean that it’s the right business structure for your business. Forming an LLC is ideal for small businesses that are mostly owned by a main sole proprietor and businesses that need liability protections to shield the owner from legal responsibilities of the company.
The LLC structure is also ideal for companies that don’t need to raise a lot of money from investors, and those who want flexibility in how the business is managed and taxed.
“An LLC is by far the easiest from the position of compliance, paperwork, and tax filing when there is just one owner. It also makes sense if you are setting up a subsidiary or secondary business and want to keep them together – an LLC has no restrictions on the types of subsidiaries you can have.
LLCs are simple, informal, and quite flexible. If you want to start a business and aren’t worried about partners or shareholders bailing out, then the LLC is the structure to go for.”
— John Engle, President, Almington Capital Inc.
After setting up an LLC, if no election is made with the IRS, then income from the LLC will pass through to the owners in the same manner as it does with a sole proprietorship or general partnership.
However, LLCs can also elect to be taxed as a C Corp or an S Corp on their federal tax return. Many LLCs elect S Corp tax status so that the business income passes through to their personal tax returns.
Normally, LLC owners must pay a 15.3% self employment tax on all of the business income (this is how self-employed people contribute to Medicare and Social Security). If you’re an LLC and want to change your federal tax status, you’ll need to fill out the correct paperwork and submit it to the IRS.
“Like a partnership (or S-Corp), an LLC enjoys what is known as pass-through taxation. In other words, each member of an LLC is taxed at an individual tax rate rather than the double taxation felt by a corporation where first the company is taxed at a corporate rate, and then each shareholder is taxed on his or her holding. In some states, an LLC must pay a yearly tax that can be almost $1000. Check with your attorney for further details.”
— Marcus Harjani, Co-Founder and COO, FameMoose
Advantages of Filing For an LLC
1. Protection from personal liability.
LLC protects its owners or members from being personally held responsible for any debts and legal obligations of the company. Creditors cannot go after the owners to seek their business assets to pay off debts or fulfill a financial obligation of the company.
However, exceptions to this rule exist in cases of misconduct and obvious negligence such as getting business loans of an unreasonable amount vis-a-vis the business’ capacity to pay.
2. Less record-keeping requirements.
The requirements for an LLC are less onerous than corporate formalities. Businesses are not legally required to hold member meetings or issue membership shares, although it may be a good idea to do so.
3. Flexibility in defining responsibilities among members.
While the flexibility of LLCs can sometimes cause confusion in terms of a member’s role and responsibilities in the company, this can be avoided by coming up with an LLC operating agreement to help them define rules and regulations that will guide their business operations. This should be able to put processes in place for running the business, roles of each member and financial structure.
Disadvantages of Filing For an LLC
1. Entire income of members are subject to income tax.
The entire income of each LLC member is subject to self-employment taxes and contributions. The business won’t be taxed on a corporate level and instead will go straight to the members who will then need to account the earnings on their personal tax returns.
Members are also subject to self-employment tax contributions such as Medicare and Social Security.
2. Unpredictable business longevity.
One of the main disadvantages of an LLC is its inflexibility in terms of member movement. Unlike other business structures, their entities can still exist even when a member departs from the company. However, this is not the case for LLC. If a member leaves, the company ceases to exist.
Bottom Line: What Is An LLC?
If you are planning to establish a business that is LLC structured, we hope that this article helped. While LLCs provide a lot of flexibility and protection, it is still advisable to determine how it will affect your overall business operations and plans in the future. We encourage you to get legal counsel before deciding on using LLC as your business structure.