In the United States, the LLC is a relatively new type of company entity. Wyoming was the first state to implement a formal LLC statute in 1977. An LLC is a business entity that combines the characteristics of a corporation and a partnership. It has been constructed in such a way that it benefits from the pass-through taxation characteristics of a partnership while allowing for operational and managerial flexibility, and maintaining the restricted liability associated with a corporation.
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How to start an LLC
Once you’ve decided to proceed with forming an LLC for your firm, there are a few procedures you must follow to accomplish this goal:
1. Decide on your state
As an LLC owner, the first thing you must do is choose the state in which you will operate your business. For the majority of new business owners, the most natural course of action is to incorporate the LLC in the state in which they reside. If your business will have a physical presence (i.e., a storefront or office) in other states, you must register a foreign limited liability company in each state where you intend to conduct business.
2. Give your LLC a name
After deciding on a location for your firm, it’s time to choose a name. Each state has its own restrictions regarding business names, but in general, you should follow the following guidelines:
- The term “limited liability company” or an acronym must be in the name (LLC or L.L.C.).
- The name cannot contain any terms that can cause confusion between your firm and a government organization (FBI, Treasury, CIA, etc.).
- Restricted terms such as “bank,” “attorney,” or “university” may require additional documentation and the addition of a licensed professional to your LLC, such as a doctor.
3. Submit to the state
Register your LLC with the state. The formation document is most commonly referred to as the “articles of organization,” although it may also be referred to as the “certificate of formation” or “certificate of organization” in some states. This paperwork, along with the state filing fee, is what establishes your LLC officially. You can submit your documentation via mail or electronically.
You will also need to give the following:
- The complete names and contact information for each of the LLC’s original members.
- The company’s name
- The LLC’s mailing address (if your business has numerous addresses, you must establish a principal address for official correspondence and tax purposes.)
- Duration of the business
- The registered agent’s information
- The LLC’s information includes a mission statement and an explanation of purpose.
4. Establish a management structure
As an LLC, you have the option of structuring your business’s management. You can have your company be member-managed, in which case a small number of LLC members are all involved in the day-to-day operations of the business, or manager-managed, in which case members opt out of managing responsibilities and delegate authority to one (or more) managers.
5. Create an operating agreement for your LLC
A limited liability company operating agreement is a legally binding contract that details your LLC’s ownership structure and member functions. While the majority of states do not require an operating agreement, it might still be useful to have everything in writing. Among the sections of an operating agreement are the following:
- Organization: This section details the date and location of the company’s formation, the members, and the ownership structure.
- Management and voting: This section discusses the management of the organization and how decisions are made.
- Capital contributions: This is where you will identify which members financially support the LLC and establish a system for future money raising.
- Distributions: This section details how the profits and losses of the business are distributed among the members.
6. Obtain an EIN
Your limited liability company’s EIN, or Employer Identification Number, functions similarly to a Social Security number. To hire staff and open business bank accounts, you will need an EIN. You can obtain a free EIN by visiting the IRS website, or by fax or mail.
7. Register to conduct business in more states
Your LLC is almost certain to conduct business beyond state lines. As a result, you must ensure that your organization is qualified in additional states. After registering in the state in which your firm is headquartered, the state in which you will pay taxes, your limited liability company must qualify in each state in which it performs significant business.
There are numerous advantages to incorporating your business as an LLC. Consider some of the most significant advantages listed below:
1. Limitation of liability
This is one of the characteristics of a limited liability company that makes it similar to a corporation. LLCs safeguard their owners from business debt and responsibility.
Consider the following example: Jimmy owns a shoe store called “boot & boot” that is losing clients to a more upscale store around the corner. The firm is struggling, and the company has fallen behind on rent and expenses for three shipments of shoes for the last eight months. As a result, “boot & boot” owes roughly $75,000 to creditors who have filed a lawsuit against the company.
In this situation, creditors have complete authority to collect money owing to the corporation but no authority over Jimmy’s personal assets (bank deposits or gold or real estate). In an LLC, only the business’s assets, not the owners’, may be liquidated to satisfy the debt.
The corporation is not subject to direct taxation by the IRS because an LLC is not regarded as a distinct tax entity. Rather than that, members are taxed on their personal income. Consider the following example.
Say that “boot & boot” has two members and has a net profit of $60,000 each year. The net gains will be divided in half (by the number of members) and taxed as personal income, based on their overall tax burden. Due to the LLC’s lack of tax recognition as a business entity, the tax return must be submitted as a corporation, partnership, or sole proprietorship.
3. Allocation flexibility
LLCs offer significant flexibility in terms of investment and profit-sharing.
Members of a limited liability company have the option of investing in a different proportion than their ownership percentage; for example, a member who owns 25% of the LLC does not have to contribute money in the same proportion as their ownership percentage for the first investment. This can be accomplished by establishing an operating agreement in which each member receives a percentage of the company’s profits (and losses), independent of the size of their initial investments. Thus, it is conceivable for an outside investor to invest money in a business without acquiring ownership.
While a limited liability corporation has several advantages over other types of business entities, there are some disadvantages to consider before choosing a limited liability company as the business structure:
1. Lifetime limitation
An LLC’s life is constrained by the tenure of its members. While state laws vary, in the majority of them, when a member leaves an LLC, the business is dissolved or ceases to exist, requiring the remaining members to complete any remaining business or legal tasks necessary to shutter the business. The remaining members may choose to form a new limited liability company or dissolve the existing one. This LLC’s weakness can be mitigated by putting relevant measures in the operating agreement.
2. Taxes on self-employment
Members of an LLC are required to pay self-employment taxes on Medicare and Social Security because they are deemed self-employed. As a result, this tax is levied on the business’s net income. To prevent this, depending on the entity’s revenue and tax burden, it may elect to be taxed as a corporation if it is more advantageous.
The fee that an LLC normally pays as initial costs or recurring charges is greater than that paid by other business entities such as a sole proprietorship or general partnership, but less than that paid by a C-corporation. Costs come in a variety of forms, including state filing fees, ongoing fees, and yearly report fees.