Limited Liability Companies (LLC’s): What You Need to Know

A comprehensive guide to Limited Liability Companies (LLCs), what they are, how to form one step-by-step, advantages and disadvantages, as well as examples, comparisons to other business types, and some FAQs.

July 9th, 2018   |    By: The Startups Team

WHAT IS AN LLC?

LLC means “limited liability corporation,” which is a type of business structure that creates a legal entity for the business that is separate from the business owner(s), meaning that the owner(s) are usually not personally liable for the company’s debts or lawsuits. Other common business entity structures such as corporation, general partnership, or sole proprietorship do not offer the same protections.

Starting a Business: Limited Liability Company (LLC)

LLCs, which can be owned by one person (a single-member LLC) or more than one person (a multiple-member LLC), are essentially hybrid entities that combine the asset protection of a corporation with the flow-through taxation benefits of a partnership or sole proprietorship.

LLCs are a popular business entity type for new and small business – and startups in particular – due to the fact that they tend to be simpler and more flexible than a corporation, while offering similar protections, not to mention easy to start.

If you choose to form an LLC, your business will become it own legal entity that has separate debts and legal matters from you as an individual. However, LLCs are still tied to your personal (individual) taxes.

HOW TO SET UP AN LLC

Step-by-step, here is how to create an LLC:

1. Decide where to form your LLC (e.g. what state). The start an LLC you must file paperwork with your state.

Most business owners will simply form the LLC in their state, but if you plan to do businesses in multiple states you may want to consider state-by-state requirements and taxes before choosing to file paperwork with the state.

2. Choose a legal business name and reserve it if possible in you state.

Requirements vary state-to-state, and you can’t register a name that is the same as that of another business entity registered in the state. Additionally, many states restrict to use of words like “bank” at the end of a name, and you must use the designation LLC at the end of your business name.

3. Choose a registered agent for your LLC.

When setting out to form an LLC, you must choose a “registred agent,” sometimes called a statutory agent. This is the person who will receive any official document (including lawsuits) on behalf of the LLC.

State-by-state requirements vary, but the person must be 18 years of age or a business entity that provides registered agent services. Many LLC’s designate a member or an employee to act as their registered agent.

4. Create an LLC operating agreement.

The LLC operating agreement will describe how you will run the LLC, and contains key information regarding how the business will be managed, rights and responsibilities of LLC members, will describe how profits and losses will be divided, and will also go into other key procedures for the LLC such as how the departure of members should be handled.

You’ll need to decide who will run the business (managers or members) and how many owners will be part of the LLC.

5. Prepare and file your formal paperwork, typically called the Articles of Incorporation with your Secretary of State.

The Articles of Incorporation (also called “Articles of Organization”) is the legal document that you must file with your state to establish your LLC.

Most states will require the name of your LLC, the duration (if not perpetual), the purpose, the name/address of the registered agent, and whether or not the LLC will be managed by it’s members, managers, etc.

You must submit your Articles of Incorporation along with your filing fee to the state – either in person, via mail, or online (if available). It may take a few weeks to process depending on the state, but you should receive a formal certificate stating that your LLC has been formed once the process has been completed.

6. Publish a notice of your intent to form an LLC (only required in a few states).

As a note, a few states have an additional requirement that you must publish a small newspaper notice of your intent to form an LLC (usually must be published several times over a period of weeks)

Additionally, you must then submit an affidavit to the state business filing agency.

There may be fees associated with this notice that have to be paid to the newspaper or to the state government.

It’s important that you check with your Secretary of State for the requirements in your state.

7. Apply for a business bank account, licenses, and other certificates specific to your industry.

Once you’ve successfully set up your LLC, you can file Form SS-4 or apply online at the Internal Revenue Service website to obtain an Employer Identification Number (EIN).

Additionally, you should now be free to set up your business bank account.

Depending on your business, you may also be required to register your LLC with state and local taxing, licensing and permitting authorities. If you are doing business in multiple states, you will also need to register your LLC to do business in those states.

Requirements vary from one jurisdiction to another, but generally your business most likely will be required to pay unemployment, disability, and other payroll taxes – you will need tax ID numbers for those accounts in addition to your EIN.

Here is a link to a great state-by-state resource for getting started with LLC’s.

WHY FORM AN LLC?

An LLC is a great way to create a barrier between your personal assets and your startup’s financial liability. It combines elements of a partnership, sole proprietorship and a corporation.

Whereas in a sole proprietorship, the owner and the business are viewed as one and the same, an LLC creates a business separate from the owner. What this means is that if the business files for bankruptcy, the members do not have to use personal money to pay the company’s debts, and if the business faces a lawsuit, the members do not risk losing their home (or other assets) to cover a settlement.

The LLC business structure combines the pass-through taxation of a partnership or sole proprietorship with the limited liability of a corporation, creating the best of both worlds for startups founders.

Simply put, forming your business as an LLC helps to protect you against lawsuits, significantly cuts down on paperwork compared to other business types (no annual meetings or minutes records are required), prevents your business from being taxed twice, and enhances your startup’s credibility.

Advantages of LLCs:

  • Limited liability protection/protected assets: as with a corporation, only the business is responsible for the debts and liabilities it incurs, not the members themselves.
  • Pass through taxation: the business is not directly responsible for tax on profits, so there’s no need to file a corporate tax return. Instead, members are responsible for both profits and loss on their individuals tax returns, similar to a general partnership. This usually results in a lower tax rate on company profits overall, and helps avoid double taxation.
  • No residency requirement:members of the LLC are not required to be US citizens or perm residents.
  • Ownership flexibility: there is no limit to number of members, and new members can buy into the business at any time.
  • Versatile tax status: the members can choose how the LLC is treated as a taxable entity. According to the IRS, an LLC is federally taxed as a partnership (in the case of a multi-member LLC) or as a sole proprietor (in the case of a single member LLC) by default; however, the LLC, may elect to be taxed as a C- or S-corporation at any time.
  • Flexible profit distribution: if the members so choose, the net income/profits of the LLC may be allocated to the members in different proportions to their ownership percentage in the LLC. Corporations, on the other hand, are required to distribute profits exactly accordance with the proportion/percentage of ownership of each shareholder.
  • Minimal/limited compliance requirements: while corporations are typically required to have at least an annual meeting of directors and shareholders, adopt bylaws, and keep minutes of all meetings and all formal corporate resolutions, an LLC is not required to do any of those things.
  • Enhanced credibility: the LLC designation means that partners, vendors/suppliers, investors, etc may look more favorable on your business.
  • Flexible management structure: LLCs are free to establish any organizational structure agreed upon by the owners, which means that the business can be overseen by the owners or by managers, unlike corporations which must have a board of directors who oversee the major business decisions of the company and officers who manage the day-to-day affairs.

Disadvantages of LLC’s:

  • Self-employment taxes: although pass-through taxation is generally considered a benefit of LLCs, it can also be a disadvantage. Sometimes the taxes reported as personal income of LLC members can be higher than taxes at a corporate level. It’s a good idea to talk to your financial advisor or account if you’re not sure whether this is your best option tax-wise.
  • Careful personal records: LLC members must to keep careful records of their business expenses separate from their personal finances in order to ensure limited liability, which means separate bank accounts and cards to track business expenses. Business accounts can also come with extra fees and restrictions.
  • LLC termination: generally if a member departs an LLC (whether by choice, bankruptcy, death, etc), then the LLC is dissolved and ceases to exist, unlike a corporation, which can exist in perpetuity regardless of if shareholders leave the company.
  • Limited growth potential: An LLC may not be a suitable option when the objective of the founder is to eventually become a publicly listed company, because LLC members cannot issue shares of stock to attract investors.
  • Lack of uniformity: An LLC can be treated differently in different states.
    Tax recognition on appreciated assets – Existing businesses converted to an LLC,can run into extra taxes.
  • Formation and ongoing expenses: LLC formation tends to be more expensive than that of a sole proprietorship or general partnership, in part due to the differing requirements around form filing as well as in some states, newspaper ads giving notice of the LLC formation.
  • Difficulties transferring ownership: ownership in an LLC is often harder to transfer than with a corporation. Typically with LLCs, all owners must approve adding new owners or altering the ownership percentages of existing owners, whereas with corporations, shares of stock can be sold to increase ownership
  • Less existing legal precedent: because the LLC is a newer type of business structure, there is not as much case law or legal precedent for LLCs as there is for corporations.

TYPES OF LLCS

All LLCs offer the same features that make them a unique hybrid of other business entities – limited liability and pass-through taxation. However, some LLC types work better or worse for particular business scenarios.

Here are some of the most common types of LLCs:

  • Domestic LLC: If the LLC is formed and operating within a given state – as in, it is conducting business within the same state it was formed – it is a domestic LLC. That state has the authority to govern the LLC if formed within their jurisdiction.
  • Foreign LLC: While the name might seem to imply that it’s an LLC that was formed internationally and is now operating in the US, this is not the case. A foreign LLC is operating in a different state than the LLC was formed in. For example, if the LLC was formed in Vermont, but is operating in Washington state.
  • Member-Managed LLC: This is where where all owners (members) are operating the business themselves, equally.
  • Professional LLC: a Professional LLC is one that performs a professional service, such as a medical or legal practice. To form a Professional LLC, it is necessary for certain members of the LLC to possess the necessary state licenses to show their professional qualifications. The limitation on personal liability does not extend to professional malpractice claims in a Professional LLC.
  • Series LLC: A Series LLC is a unique type of LLC where a single “parent” LLC provides limited liability protection across a series of “child” businesses. Each “child” business is also protected from the liabilities of the other businesses under the single Series LLC. Currently, you can only form a Series LLC in seventeen states: Alabama, Delaware, Washington D.C., Illinois, Indiana, Iowa, Kansas, Minnesota, Missouri, Montana, Nevada, North Dakota, Oklahoma, Tennessee, Texas, Utah, and Wisconsin.

Less Common LLC structures:

  • Manager-Managed LLC: This type of LLC allows for some of the business partners to remain passive in running the business by delegating either members or nonmembers as a manager.
  • Restricted LLCs: Restricted LLCs are a type of LLC available in Nevada only that were launched in 2009. These types of LLCs choose to be restricted within their Articles of Organization and therefore cannot make certain business distributions among members until 10 years after forming their LLC.
  • L3C: An L3C company is a for-profit company with a stated philanthropic social purpose. This type of LLC is a hybrid business structure that uses the legal and tax flexibility of an LLC, the social benefits of a nonprofit organization, and the branding and market positioning advantages of a social enterprise.
  • Anonymous LLC: An anonymous LLC is where the ownership details of the LLC are not made public by the state in which the LLC is registered. New Mexico is one of the only states that allows for truly anonymous LLCs.

EXAMPLES of LLC’s

In addition to a growing number of startups, examples of LLCs include YouTube and Albertson’s (which owns Safeway).

DIFFERENCES BETWEEN LLCS AND OTHER BUSINESS ENTITIES

LLC vs. Sole Proprietorship:

Limited liability is one of the main advantages of an LLC over a sole proprietorship, along with not being taxed as a self-employed person, unlike with a sole proprietorship.

On the other hand, sole proprietorships generally are less costly compared to an LLC, and LLCs need to register with the state and pay initial registration or filing fees, often have annual fees which must be paid to maintain your registration, are subject to state laws governing LLCs, and require members to keep both LLC records and funds separate from their own personal records and funds.

LLC vs. S Corp:

Both LLCs and S corps benefit from limited liability protection, being separate entities, pass-through taxation, and being subject to going state compliance requirements.

However, as compared to LLCs, S corps have stricter rules about ownership, have more mandatory requirements and internal formalities; have directors and officers and shareholders do not manage daily business affairs; has freely transferable stock; and shareholders must receive their profits and losses based on their percentage of ownership.

LLC vs. C Corp:

Unlike both LLCs and S corps, C corps are taxed as separate entities and are also subject to “double taxation” if corporate profits are distributed to owners (shareholders) in the form of dividends.

C corporations pay tax on their profits first at the entity level and then owners pay taxes at the individual level on profits received as dividends, resulting in the double tax. C corps can also retain and accumulate earnings (within reasonable limits) from year to year.

Like LLCs, C corps don’t have restrictions on the number of owners the business can have or who can be an owner.

LLC vs. LLP:

Limited Liability Partnership, or LLPs, have the same tax advantages of LLCs, but cannot have corporations as owners.

Additionally, unlike LLCs, LLPs must have at least one managing partner who bears liability for the partnership’s actions.

LLC vs. Ltd:

LLCs and Ltds are most similar, with only a few minor differences, with the primary one being that Ltds are subject to double-taxation.

LLC FAQs

Can an S-Corp own an LLC?

Yes. An S-corp may own up to 100 percent of an LLC. The similarity of tax treatment for S corps and LLCs eliminates most of the common concerns about IRS issues.

Are a corporation and an LLC the same?

No. While an S corp is a “pass-through” tax entity, like the LLC, C-corps are taxed as separate entities. They are also subject to “double taxation” if corporate profits are distributed to owners (shareholders) in the form of dividends.

About the Author

The Startups Team

Startups is the world's largest startup platform, helping over 1 million startup companies find customers, funding, mentors, and world-class education.

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