Why Form an LLC: Everything You Need to Know
Why form an LLC? An LLC, or a limited liability company, operates essentially as a corporation, sole proprietorship, and partnership all in one.5 min read
Why Form an LLC
Why form an LLC? An LLC, or a limited liability company, operates essentially as a corporation, sole proprietorship, and partnership all in one. An LLC affords its members with limited liability as they cannot be held personally liable for the company’s debts. An LLC is a sole legal entity, and the name you choose for your LLC is the legal name of your company. This means that the name of your company is the name you will use when conducting business.
The legal name of an LLC lasts until the business is dissolved. Once an LLC is in existence, the owner has the option of also filing a DBA to conduct business under a name different from the registered LLC business name. The members of an LLC can choose whether they want to be taxed as a sole proprietorship, corporation or partnership. LLC members owe Social Security and Medicare taxes, but such taxes can be paid through the members’ self-employment tax form.
Advantages of Forming an LLC
- Operating an LLC can help you gain credibility with potential customers, vendors, partners, and employees.
- An LLC offers protection against personal liability, including personal assets; therefore, an LLC is the preferred business type when liability is an issue, i.e. when the company hires employees.
- Owners will not be personally liable for decisions or actions taken by the LLC.
- When your company expands, seeking funding is a much more straightforward process.
Difference Between an LLC and a Partnership
A partnership is an entity formed when at least two or more individuals agree to go into business with one another. More specifically, there are two main types of partnership structures, which include general partnerships and limited liability partnerships, also referred to as limited partnerships. There are no filing fees associated with establishing a partnership nor are partnerships required to hold meetings, prepare meeting minutes, appoint officers, or issue shares of stock as with the formation of an LLC. Keep in mind, however, that unlike with an LLC, creditors can initiate legal proceedings against the partnership itself, including the assets of the partners, i.e. house or automobile.
Difference Between an LLC and a Corporation
A corporation is a legal entity operating under the state laws in which the business is incorporated. A corporation is treated as a person for all intents and purposes. Therefore, a corporation can sue and be sued, buy or sell real estate, and even break the law, which is much different than the treatment of an LLC. There are generally two types of corporations—S corporations and C corporations. S corporations are pass-through tax entities whereas C corporations are completely separate entities from its owners. A significant distinction between C corporations and businesses that operate as pass-through entities is that owners of C corporations are taxed only on income received. Since a corporation is taxable, the profits leftover after being incurring corporate taxes are not taxed to the owners. Such profits are only taxed when distributions are paid to shareholders in the form of dividends. However, this would be the case for unincorporated businesses and S corporations.
Some benefits to forming a corporation include:
- A business that is incorporated can file lawsuits and buy/sell property.
- Incorporation even means that the company can commit a crime, i.e. tax fraud or another type of business crime.
- Incorporating is simple. Simply file an application within the specific state.
- All 50 states, including the District of Columbia, recognize both LLCs and corporations.
- A corporation can evade double taxation of the profits and dividends by choosing Subchapter S tax status.
- Corporations can deduct normal business expenses before they are apportioning income to owners.
- Corporations can easily transfer ownership through a transfer of securities to the new owner.
- Corporations can operate for an unlimited period of time.
- Corporations can create tax benefits, but C corporations might be exposed to double taxation of profits.
- Those businesses set up as S corporations can pass through income to the shareholders.
- The IRS generally taxes corporations at a reduced tax rate than individuals.
- Corporations can issue shares of stock.
- A business that is incorporated can take its company public.
How to Set Up an LLC
LLCs are formed under state laws - which vary state by state - when an individual files the Articles of Organization with the Secretary of State’s office in the state you choose to register. A name availability check can be conducted on the Secretary of State’s website in order to ensure that the name is not currently being used. An LLC business owner is required to report any changes in address, membership, or service and must also file an annual report that includes important business and financial information. The legal name of an LLC lasts until the business is dissolved. When broken down step by step, the following actions must be taken when forming an LLC. Keep in mind, however, that some minor adjustments may be made depending on the state in which you are forming your LLC.
Step 1. Naming your LLC is the first step in establishing your company. You’ll need to conduct some research to ensure that the name is not previously taken by another business. Other guidelines, rules, and tips apply as follows:
- The name must include LLC, L.L.C., or Limited Liability Company at the end of the business name.
- Certain words are prohibited, including Bank, University, College, Attorney, Doctor, Treasury, etc. This is a rather simply concept to understand. Your LLC is not a financial or educational institution. You cannot include terms like “attorney” or “doctor” unless a licensed individual having such educational credentials are part-owners in the LLC.
- The name of your LLC must be written in English letters, Arabic numerals, or Roman numerals.
- The name cannot include punctuation marks or symbols, i.e. dashes, question marks, colons, etc.
Step 2. Choose a registered agent. This is a required step in the process. The registered agent will accept and send papers on your behalf, including annual filings as well as service of process in the event a legal battle ensues between you and another party. See above for additional requirements when choosing a registered agent.
Step 3. File the Certificate of Organization. There will be a $70 fee when filing the certificate of organization; however, it can be done quicker for an additional fee of $75. The following information will need to be included in this document:
- The LLC name
- Number of shares that will be issued, and if more than one class or series of shares it to be issued, this information must be included. Keep in mind that a charter fee will apply here. This fee will depend on the number of shares being issued.
- The registered agent name/address
- This document must be signed by one or more of the incorporator
Step 4. Draft the operating agreement. This document, while not required in several states, is highly recommended. The agreement outlines the ownership structure and daily operating procedures of your LLC. This document should be carefully drafted to include all important items regarding the operations of the LLC, accounting methods and retention of records, as well as other important decisions to be made when developing your LLC.
Step 5. Obtain an EIN. You must obtain an EIN, or Employer Identification Number, for your LLC, which is a Social Security number for your business. An EIN is required to open a business bank account, for federal and state tax purposes, and must be done in order to hire employees. You can obtain an EIN from the IRS after forming your company. There is no filing fee. Obtaining an EIN can be done online or by printing and mailing the form.
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