Are you a small business owner who has been asked if their company is an LLC, and you don’t know what that means? Or maybe you are an entrepreneur in the early stages of opening a new venture, and your head is swimming with all the options ranging from a sole proprietorship to an LLC to a corporation.
Keep reading for everything you need to know about an LLC and whether it’s the right choice.
What is a limited liability company?
A Limited Liability Company (LLC) is a business structure that provides owners with protections normally only available to corporations but keeps the sole proprietorship simple.
This entity also provides pass-through taxation as it is operated through a separate entity that is not restricted to a certain number of shareholders and is not highly regulated.
Related: How to start a Limited Liability Company (LLC)
What are the benefits of an LLC?
There are benefits to every business structure. Corporations, general partnerships, and sole proprietorships each offer unique advantages.
The benefit of forming an LLC is that it takes the positives of each business structure and combines them into one.
How can an LLC provide asset protection?
One of the main advantages of an LLC is that it protects your personal assets.
For any business debts or lawsuits your business may face, the owner assumes no personal responsibility. This ensures that their personal assets cannot be taken as payment as they are completely separate from the company.
Related: LLC Basics – Entrepreneur.com
What tax options does an LLC have?
An LLC provides more tax options than other business models.
For tax purposes, they are taxed either as a sole proprietorship or partnership, depending on the management structure and the number of members participating in the business.
Members report their share of business income and expenses on their personal tax return and then pay personal income tax on the earnings.
Members who also work for the corporation are considered self-employed and must report this on their federal tax return and then pay self-employment taxes on their share of the profits.
If a corporation does not want to be taxed as a sole proprietorship or partnership, it can also choose to be taxed as an S corporation (S-corp) or a C corporation (C-corp).
A C-corp pays corporate tax, and the owners pay tax on their distributions. An S-corp is what is known as a pass-through entity which means it does not pay corporate tax, but each owner pays personal income tax on their share of the profits.
It is important to note that not all LLCs qualify for S-corp taxes as they must meet the requirements of the IRS (Inland Revenue Service).
A one-member LLC can also be designated as a disregarded entity. What this means is that it will be ignored or disregarded in relation to federal income tax.
Related: The 5 biggest tax differences between an LLC and a contractor corporation
Does an LLC Offer Flexibility?
Because LLCs are not required by law to hold annual meetings of shareholders or even require a board of directors, they offer more flexibility than other business models.
Instead, the members of the LLC are free to organize the company as they see fit and it is managed by the members, as administrative requirements like most corporations do not bind them.
Related: Choose your business structure | contractor
Does designating an LLC make your business more credible?
When you build your business as an LLC, you gain exclusive rights to use your business name as a business entity.
Since most states don’t allow a corporation to use an existing business name, you can create a public registry of your name, making it unavailable.
Designating an LLC at the end of the company name can add credibility to a business.
Related: How to Structure a Single Member LLC | contractor
How are profits distributed in a limited liability company?
One of the main advantages of the LLC is that the members can decide how the profits are divided.
Corporations usually issue dividends, and partnerships usually split profits among partners, but LLC owners can choose how profits are divided.
Remember, the IRS has rules about private allocation of earnings, and you may have to show evidence of profit sharing or a legitimate economic need to prove it’s not just an attempt to avoid paying taxes.
Are there disadvantages to an LLC?
While an LLC has definite benefits, it also has some notable drawbacks.
Earnings are subject to a high LLC tax
LLC profits are subject to Social Security and Medicare taxes. In some cases, the LLC owners may end up paying more in taxes than the corporation does.
Also, both salaries and profits of an LLC are subject to self-employment taxes which are currently equal to about 15.3%. Whereas with a corporation, only salaries are subject to taxes, not profits.
This disadvantage hits owners with a salary of less than $97,500 the hardest.
Related: LLC Pros and Cons | contractor
The LLC must immediately recognize its earnings
Unlike a corporation, LLC owners are required to immediately recognize their earnings.
C-corp does not have to immediately distribute its dividend to shareholders. This means that C-corp is not always taxed on the company’s profits.
Since an LLC is not subject to double taxation, the company’s profits are automatically included in the member’s actual income.
Related: Basics of Business Structure | creation | contractor
There are fewer additional features available
Employees who receive additional benefits such as group insurance, medical reimbursement, medical insurance, and parking must treat those benefits as taxable income with the LLC. This is also true for employees who own more than 2% of an S-corp.
On the other hand, C-corp employees who receive additional benefits do not have to report them as taxable income on their tax returns.
How to set up a limited liability company
There are seven steps you need to take to start an LLC.
There are different state law requirements from state to state, so it is recommended that you speak to a legal professional about the specific requirements where you live.
Choose a business name
The first step to starting an LLC is choosing your business name.
Not only do you need to choose a name that doesn’t already exist, but your state may also have certain requirements that you must meet.
Related: How to Name a Company: 7 Useful Tips | contractor
Choose a registered agent
The next step is to choose a registered agent. The registered agent receives official and legal documents on behalf of the company. Once the registered agent receives these documents, he passes them on to the company.
The registered agent must be at least 18 years old. You are allowed to choose yourself or an employee. The main requirement is that the agent has an address within the state during normal business hours.
Related: 4 Best LLC Services for 2023 | Business directory
Obtain a copy of the organization form for your state LLC
In most states, you will have to file a document called the Articles of Organization with the state agency that handles business files to set up an LLC.
Each state has a specific form that you will use; Some also call it a certificate of formation.
Complete the LLC Articles of Association form
Each state has specific requirements for individuals trying to set up an LLC. Some of the typical information you may need to provide includes:
- Business name.
- The main address of the business.
- The purpose of the work.
- How will the LLC be managed?
- Registered agent contact information.
- Term of a limited liability company.
Once this form is filled out, at least one of the business owners will need to sign it.
Related: Ten Steps to Organizing a Limited Liability Company | contractor
Organization material file
Be sure to review the sample organization materials thoroughly before submitting them.
You may also be required to pay a registration fee, which varies from state to state.
Once your form is approved, the Secretary of State’s office will issue you with a certificate to prove that your LLC is officially registered.
You can use this certificate to complete tasks such as setting up a business bank account and registering for a tax ID number.
Related: Choose your business structure | contractor
Create a limited liability operating agreement
Now that the state has approved you, it’s time to create an operating agreement.
The operating agreement sets out all the details of the financial, legal, and management rights that all LLC members are entitled to.
In particular, it includes how profits are distributed, how members can leave the LLC and who is required to contribute capital.
You can create your own operating agreement, especially if you are a single-member LLC. Hiring a lawyer may be a good option for more complex situations, such as multi-member LLCs.
Related: Why Many Limited Liability Operating Agreements Fail | contractor
Keep your LLC active
Now that your LLC has been created, you need to keep it active.
This means that you must ensure that you keep your business in good standing with your state. This can include your LLC filing an annual report that keeps your company information up-to-date and paying an annual filing fee.
Related: Business – The Many Benefits of Forming an LLC | contractor
Start an LLC today
With benefits ranging from business flexibility, various tax options, and personal asset protection, setting up an LLC may be the next step your business should take.
By following the above steps and consulting with an attorney in your area, you can soon be running an LLC and reaping all of its benefits.
paying off Other entrepreneur articles for more information About LLCs and other financial topics.
