Choosing the right legal structure for your business is crucial. Whether you are venturing out alone or teaming up with partners, registering your business as a limited liability company (LLC) offers a straightforward and flexible option for your business's framework. Here's what you need to know about LLCs.
What is an LLC?
An LLC is a flexible business structure that protects owners — or "members" as they are referred to in an LLC — from being personally responsible for their company's debts or legal troubles. Unlike a partnership, where owners share personal liability for the business's obligations, an LLC separates personal and business assets. This means members' assets, like their homes or savings, are safe if the business faces financial issues.
The benefits of starting an LLC
An LLC is one of the least complex business structures because it offers flexibility by combining positive features of other business entities. LLCs provide the tax simplicity of sole proprietorships and partnerships while having the limited liability protections usually provided by corporations. Here are five benefits of starting an LLC.
Fewer restrictions on structure and ownership
LLCs offer flexibility not only in how they operate but also in who can own them and how they're structured. Depending on state regulations, members of an LLC may include individuals, corporations, other LLCs, foreign entities, and more. The IRS places no restrictions on the number of members an LLC can have, so it can be a single-member or multimember entity.
Single-member LLCs generally resemble a sole proprietorship, whereas multimember LLCs resemble a partnership. However, an LLC may elect to be treated as a corporation.
Pass-through taxes
One of the biggest benefits of an LLC is that all profits go directly to the business owners. The owners file their share of the profits on their individual tax returns, meaning the profits are only taxed once. This is referred to as pass-through taxation.
Corporations, on the other hand, must pay taxes twice — first when profits are distributed to the owners and again when they file their individual tax returns. For many small business owners, pass-through taxation is a financial benefit too good to pass up.
Personal liability protection
Members of an LLC have limited personal liability with their business's finances. Unlike other business entities, members are not personally responsible for the business's debts or lawsuits, so long as members don't participate in fraud or criminal behavior.
Credibility
One of the less obvious benefits of forming an LLC is the added credibility you gain with clients, suppliers, and lenders. LLCs are recognized as a more formal business structure than a sole proprietorship or partnership and show you are a credible business.
Access to business loans
While sole proprietors can apply for business loans, lenders are often reluctant to approve them. Established LLCs, with their formal legal structure, are typically viewed as a lower-risk option for lenders.
Once you have formed your LLC, your business will start building a credit history that can help you access loans or lines of credit from lenders.
[Read more: The Most Common Business Entities for Startups]
Unlike a partnership, where owners share personal liability for the business's obligations, an LLC separates personal and business assets.
Disadvantages of an LLC
The flexibility provided by an LLC has many benefits, but there are some downsides to this type of business entity, such as the following:
- High up-front costs: LLCs may have higher startup costs and annual fees compared to sole proprietorships or partnerships, depending on the state in which it is registered.
- Limited capital-raising options: Unlike corporations, LLCs don't allow for the distribution of stock, which can limit options for raising more capital.
- State-specific regulations: The rules and regulations governing LLCs vary by state, which can create complexity for businesses operating in multiple states.
- Potential tax disadvantages: Members of an LLC may have to pay self-employment taxes on their share of profits, which can be higher than corporate tax rates.
Is an LLC right for your business?
An LLC is a popular option among small business owners because it provides the perfect balance between simplicity and personal asset protection. However, when you're choosing what type of business entity your business should be, you need to carefully consider your options.
An LLC is right for you if you meet the following criteria:
- You want to limit your personal liability for business debts.
- You want to raise capital from new business partners and investors.
- You want to avoid double taxation.
No matter which entity you choose, it's important to select one that will grow with you. It can be difficult to change your business structure from a sole proprietorship or partnership to an LLC after you've already registered, so do your research and select the one that most benefits your long-term business goals.
[Read more: Sole Proprietorship vs. LLC: Which Structure Should You Choose?]
How to start an LLC
Starting an LLC is a straightforward process, but certain requirements demand careful attention to detail so that your business is set up for success. Here are the steps to start an LLC:
- Determine where to register. Decide which state you'll register your LLC in, typically where your business is based. Registering in a different state with lower fees or taxes may seem beneficial, but it can lead to extra costs and paperwork.
- Choose a name for your LLC. Choose a name that complies with your state's naming rules; most require the name to include "LLC" or "Limited Liability Company."
- File your articles of organization. To file, find your appropriate state agency, usually the secretary of state. This document officially registers your LLC and includes key details like your business name, address, and members.
- Find a registered agent. A registered agent ensures that a person is available to receive legal and official documents on behalf of your LLC. Most states require LLCs to have a registered agent with a physical address in the same state as the LLC.
- Write your operating agreement. An operating agreement outlines the management structure and operational rules for your business. This document defines member roles, profit distribution, and day-to-day business operations.
- Meet all regulatory requirements. This includes filing the necessary formation documents, such as the articles of organization, and meeting any licensing or permit requirements based on your business type and industry.
Consulting with an attorney or accountant who specializes in LLC operations can help ensure you are compliant with regulations.
How to transition from a sole proprietorship to an LLC
Transitioning from a sole proprietorship to an LLC can provide added protection and flexibility for your business. Here are the steps for changing from a sole proprietorship to an LLC:
- Confirm that your business name is available. Conduct a name search with the secretary of state, and check the U.S. Patent and Trademark Office (USPTO) database to ensure the name isn't trademarked or conflicts with existing trademarks.
- File your articles of organization with your state agency. This step includes providing basic details such as the LLC's name, address, purpose, the registered agent, and management structure, as well as paying a filing fee.
- Write an LLC operating agreement. Outline the rights and obligations of members, including the voting rights, profit distribution, exit procedures, and noncompete clauses.
- Obtain a new EIN. Even if you have an employer identification number (EIN) for your sole proprietorship, you'll need to file Form SS-4 to obtain a new EIN for your LLC, which is used for tax filing and reporting.
- Apply for a business bank account. Since LLCs and personal assets are separate, it's important to open a dedicated bank account for your LLC.
- Apply for any necessary business permits and licenses. You might need to acquire extra licenses and permits based on your industry or state. An attorney or LLC service can guide you through this process.
[Read more: Starting a Business? A Guide to Business Licenses and Permits]
This article was originally written by Emily Heaslip.
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