Limited Liability Companies (LLC) are business entities that got their start in 1977 and are considered to fit somewhere between sole proprietorships/partnerships and fully incorporated companies. Existing to fill the gap between corporations and sole proprietors, LLCs can help to segment personal and business assets and liabilities while at the same time maintaining a simplified tax structure. An LLC is not a corporation, but it is a company structured to operate like a corporation.
An LLC is its own legal entity, so long as it is treated as one. The LLC can assume obligations of debt. In other words, the LLC, not the members, hold a loan and the liabilities that go along with it. If, however, the members of an LLC use the entity as their personal bank or for personal matters, it is possible that the LLC will not be recognized as a separate entity if a lawsuit is filed.
As far as taxes go, LLCs are considered by the IRS as pass-through entities. This means income passes through the business and goes straight to the LLC members, just as they would with a sole proprietorship or partnership. These profits or losses are filed on each individual’s tax return. A caveat to this is that LLCs can be taxed as a corporation if the members elect to do so. So, if treated appropriately, an LLC can shield its members from the liabilities of a corporation without assuming the tax overhead a true corporation must maintain.
How to File
If you are thinking about forming an LLC for your business, spend the next 20 minutes educating yourself on the difference between sole proprietorships, LLCs, and corporations. My guess is that for most people starting out, a sole proprietorship will be sufficient for current needs and much cheaper than filing for an LLC.
If you have done your homework and have decided that an LLC is the way to go, what next? The steps to filing an LLC are not complex and although requirements vary from state to state, setting up an LLC is a simple process that can usually be done in an hour.
The first step is to contact your secretary of state and obtain the required form for filing a LLC. In some cases this will be a simple fill-in-the-blank form. The state of Washington, for example,
has an online application. The process guides you through establishing a legal business name. completing the certificate of formation, establishing the registered agent, defining the members, as well as guides you through the initial annual report. The fee for WA is roughly $200, and additional costs may apply depending on how you file. Google your secretary of state to find out more of the specifics.
As you fill out your articles of organization, you will be required to define the registered agent for the LLC. In most cases this will be you. The registered agent is the person or business that is designated to receive important documents on behalf of the LLC. The most appropriate individual for this is generally the one spearheading the business.
The operating agreement is the internal agreement between the members of the LLC. It is not required to form the LLC, but it should be drafted to state the rights and responsibilities of the members. The operating agreement should contain but is not limited to the following;
- Capital Contributions. How are the members expected to make capital contributions if the business needs additional capital?
- Management Decisions. When the members are faced with important management decisions, does each get one vote, or do they vote according to their percentage interests in the LLC? Majority shareholders may feel they deserve a larger say.
- Financial Withdrawals. How do owners go about withdrawing from the profits of the business?
- Buy Out/Cash out. How do members leave the LLC? Will they receive an immediate payout of their capital contributions?
- Compensation. If a member does leave, how much should they be paid?
- Share. While there are not actual shares within a LLC, it should be defined how or if a departing owner is allowed to sell an interest to an outsider.
Publish a Notice
Some states require a notice of intent to be published. This can be as simple as running a classified ad in your local paper. Specifics on this will vary and your secretary of state can provide you with the steps required.
The last bit to think about is obtaining other appropriate insurance, permits, and licenses for your new LLC. Each industry had its own unique set of requirements, so be mindful of this once your business is established.
Category: Personal Finance