One of the most important early decisions business owners must make is what business entity to register under. There are plenty of business entity types to choose from—a sole proprietorship, C corporation, S corporation, limited liability company (LLC), or limited liability partnership (LLP). What business structure you decide on depends on the risk you're willing to assume.
If you are looking for more liability protection than a sole proprietorship can give but are not ready to register as a C corp or an S corp, an LLC is an excellent choice. Before you apply for LLC formation, read on to determine if it's right for you.
Benefits of forming a limited liability company
The most significant benefit of an LLC is limited liability. According to Fareed Kaisani, an attorney with Dallas-based Platt Cheema Richmond PLLC, "This means that the owners (also known as members) are not personally liable for the company's debts or legal liabilities."
In addition to personal liability protection, "LLCs also have the option to choose how they are taxed," Kaisani says. "They can be taxed as a sole proprietorship or partnership (if there is more than one member), or they can elect to be taxed as a corporation," the latter of which can result in significant tax benefits.
Just choosing to become an LLC, however, is not enough. You'll need to delve further into the types of LLCs to determine the type which fits your situation.
Another benefit is that an LLC is a relatively simple and flexible structure. "Members can be foreign or U.S. individuals, partnerships, trusts, corporations, or other LLCs," explains Bianca Lindau, a corporate associate at Boston-based Caldwell Intellectual Property Law.
Foreign entities can also be LLC members. Insurance companies and banking institutions usually are not allowed to be LLCs. Check your state or the state you'll be conducting business in for additional or different regulations.
Just choosing to become an LLC, however, is not enough. You'll need to delve further into the types of LLCs to determine the type that fits your situation. "Owners of an LLC must pick the sort of LLC they want and if they want to actively participate in daily decisions and operations or prefer to be more hands off," Martin Gasparian, an attorney and owner of California-based Maison Law, says.
Steps to apply for an LLC
1. Choose one of the 5 types of LLCs
An LLC is not a one-size-fits-all legal entity. There are several types of LLCs, one of which can be split up into four categories of its own.
Let's break them down.
In general, there are:
- Member-managed LLCs. Owners of this type of LLC, known as members, run the company. Only a specific person or group of people can run the company.
- Series LLCs. This type of LLC is structured similarly to a corporation with several subsidiaries. It has a parent or umbrella LLC with one or more sub- or series LLCs underneath. "Each series LLC is separate from the others, and its liability is limited to its assets," Lindau says. Such a structure "allows risk to be segregated within separate entities without the cost of setting up new entities."
- Restricted LLCs. Nevada recognizes this type of LLC. With a restricted LLC, "profits cannot be distributed to the owners for at least 10 years beginning on the date of formation or conversion to the restricted LLC," Lindau says. Often used in Nevada for estate planning, a restricted LLC's main benefit is that profits aren't taxed during those 10 years but rather are paid upon distribution at a significantly lower rate due to the valuation discounts.
- Anonymous LLCs. The true identities of the members are not publicly disclosed with this type. States that offer this type of LLC include Delaware, New Mexico, Nevada, and Wyoming.
- Professional LLCs. "This type of LLC is specifically designed for professionals, such as attorneys, doctors, and architects," says Min Hwan Ahn, an attorney and founder of EZ485, which assists people with immigration and visa applications. "The protection is the same as other limited liability companies, "but with the added requirement that all members must be licensed professionals in the same field."
Member-managed LLCs get a bit more granular. They can be single- or multimember, and the multimember can be further categorized by members' relation to each other. If the members are related, the LLC can be a family LLC. If they aren't related to each other, the LLC could be called a general LLC. (Not all states recognize these unique forms of LLC.)
Once you've chosen your form of LLC, you can move on to the next step.
2. Choose a business name
Spend some time thinking about your new LLC's name. Marketing and brand purposes are not the only considerations you must make. There are other important legal considerations as well.
The name of your business will need to include "LLC" in the name. You also must ensure your name doesn't include any restricted words as defined by your state. For example, the words "bank" and "insurance" are commonly restricted by most states. Check your state business office's website for its list of restricted words.
You must also take the time to make sure a name isn't already being used in your state. If your name is available, your state may allow you to reserve the name until you get your documentation filed. In most states, your business name will be automatically registered when you file your articles of organization, so you most likely won't have to register your name separately.
You also don't want to infringe on any existing trademarked names. The Trademark Electronic Search System offers a database of registered trademarks and prior pending trademark applications and is maintained by the U.S. Patent and Trademark Office. This step isn't required, but it's a smart business move. You don't want to end up with a name that's too similar to another business' name.
In addition to all this, you'll want to purchase your business name or some permutation of it as a domain name.
3. Register a DBA name
Once you have your name, you'll have to decide if you want to do business under that name. If you plan to run your company under a name different from your business name, you will need to register a "doing business as" (DBA) name. Also known as an assumed or trade name, a DBA is a name different from your LLC's officially registered business name. Not all states require a DBA to be registered, so check with your state's business office to determine the process you'll need to follow if you're planning to use a DBA name.
4. File articles of organization
To create your LLC, you'll need to file articles of organization with your state. The articles may be called something else in your state, like articles of formation, but they're all the same thing.
Your state's business or filing office will typically have an easy-to-fill-out document you can obtain in-person or online. The information required varies from state to state, but you typically only need to provide the name and address of your LLC and the names of its members.
Once you've completed the form, file it with your state along with the filing fee. The U.S. Small Business Administration maintains a list of links to state business offices on its website. Visit the appropriate state site to obtain more information about the proper place to make your filing and enquire about the required filing fee (if any).
5. Designate a registered agent
This is a requirement in most states. A registered agent, also known as an agent for the service of process, is the person who will receive service of process notices, government correspondence, and compliance-related documents on behalf of your business. The agent is typically one of the LLC members.
6. Draft your operating agreement
This document provides a structure for important internal business decisions. Even though it is not required in many states, it is an extremely wise move to have one because it provides clarification on key issues. The operating agreement covers matters such as the percentage of ownership among members, voting rights and responsibilities, members' powers and duties, and provisions governing the transfer of members' interests. Check with your state's business office to see if an operating agreement is required.
7. Publish a notice of formation
Some states require you to publish a notice in your local paper announcing the formation of your LLC. Check with your state's business office for information regarding the content of the notice, how many times it must be published, and any other requirements that might apply.
8. Obtain a business license and permit
Most small businesses will need some type of business license or permit. The types of licenses or permits you'll need will depend on both your state and local government requirements and the industry your business is in. Check with your city, county, and state business offices to learn what is required.
9. Obtain an EIN number
This is not always required, but many financial institutions prefer employer identification numbers (EINs) over Social Security numbers when opening bank accounts for your business. If you plan on having any employees in the future, this is actually required for you to have for federal tax purposes. Obtaining an EIN is simple and quick. Go to the IRS website to fill out a short form, and when you submit the form, you'll have your EIN. You can print out the accompanying letter, and one will also be mailed to you.
10. Open a business bank account
Once you get your business license, you'll want to open up bank accounts for your business. "Having a separate account for the business is helpful, as this gives one an overview of income and expenses, making accounting efforts and financial decision-making easier," Lindau says.
Typically, LLCs have one or more of the following:
- Business checking: Allows for depositing and withdrawing funds, writing checks, and making online transactions. The accounts often have fees, but they also offer various features, such as overdraft protection, merchant services, and credit cards.
- Business savings: This account earns interest on extra funds, though the interest rate is typically lower than personal savings accounts, but may offer more benefits for business owners.
- Merchant services: You'll want this account if you want to accept debit or credit card payments. This account allows you to process card payments and directly receive funds in your business checking account.
- Business line of credit (LOC): For short-term financing, an LOC can be handy. It allows your company to borrow funds as needed and pay them back over time like a credit card. A LOC usually requires collateral and has a higher interest rate than other types of loans.
"It's important to shop around and compare the fees, interest rates, and features of different types of bank accounts to find the best fit for your LLC's needs," Kaisani says.
Other things to consider for your LLC
State and local formation and maintenance costs should be taken into consideration when choosing to form an LLC. "There are filing fees, state fees, and ongoing costs such as annual reports, taxes, and legal fees," according to Kaisani.
Using the state of Nevada as an example, LLC formation filings cost $75. There is a 24-hour expedite fee of $125. Also included in the setup costs are the cost of the annual list ($150) and business license ($200). To have a business in Las Vegas proper or greater Las Vegas, additional fees apply. Once the state filing is completed, a general service business would pay $100 for the local business license and $50 for processing, and if the business is home-based, you can add an additional $50. There is no single price for a business license in Las Vegas.
If you plan to do business in other states, consider that you'll have to "foreign qualify" in the new state, which means additional fees.
"Another consideration is the recordkeeping involved," Kaisani says. "LLCs are required to maintain proper records and documentation, including the company's operating agreement, financial statements, and meeting minutes," which can be time-consuming and may require the help of a professional, especially for unique partnership situations. “Often, small business owners do not understand the sophistication of what they are trying to accomplish with their company agreement terms. I always recommend consulting with a licensed attorney in your state when considering forming a new company of any type."
If you plan to do business in other states, consider that you'll have to "foreign qualify" in the new state, which means additional fees. "A business owner who has formed an LLC in one state and wishes to grow into another can do so," says Gasparian. "Foreign qualification is the procedure for acquiring authorization to carry on business in the state where they intend to increase the scope of their current corporation's operations." The qualification is necessary when a firm has a physical presence or economic connection to the additional state, reaching a certain income threshold in the new state.
The IRS also has further information on forming limited liability companies.
Is having an LLC worth it?
There's no easy answer to that question. "It depends on your situation," Lindau says. "LLCs can be used for various purposes, from holding property to running a business. It's likely not worth the time and cost if the business is short term or a one-off."
But it is worth the time and expense if you intend to grow your small business and when it is likely that your industry will deal with third parties. "However, choosing the best entity for your business," says Lindau, "should ideally be carefully and comprehensively assessed with knowledgeable counsel, considering all relevant facts and circumstances."
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