If you’re a small business owner who’s been asked if your business is an LLC, but you’re not sure what that means, or you’re an entrepreneur in the early stages of starting a new business and feeling overwhelmed with all the options—from a sole proprietorship to an LLC to a corporation—read on to learn everything you need to know about LLCs and whether it’s the right choice for you.
An LLC, or Limited Liability Company, is a business structure that provides owners with protections usually only available to corporations, but maintains the simplicity of a sole proprietorship. This entity also provides transfer taxes, as it is managed through a separate entity that is not restricted to a specific number of shareholders and is not heavily regulated.
One of the main advantages of forming an LLC is that it protects your personal assets. For any business debt or judgment your business may have, the owner has no personal liability. This ensures that your personal assets cannot be taken as payment as they are completely separate from the business.
An LLC offers more tax options than other business models. For tax purposes, they are taxed as a sole proprietorship or as a partnership, depending on the management structure and number of members involved in the company. Members report their share of business income and expenses on their personal tax return and then pay personal income tax on the earnings. Members who also work in the business are considered self-employed and must report this on their federal tax return and then pay self-employment tax on their share of the profits.
Since LLCs are not required by law to hold annual shareholder meetings or even require a board of directors, they provide greater flexibility than other business models. Rather, members of an LLC are free to organize the company as they see fit and be managed by members, as administrative requirements like most corporations do not bind them.
While an LLC has specific benefits, it also has some notable drawbacks. For example, profits are subject to high LLC tax, and employees who receive fringe benefits must treat these benefits as taxable income with an LLC.
To set up an LLC, there are seven steps you need to take, such as choosing a business name, choosing a registered agent, obtaining a copy of the LLC’s articles of organization form from your state, completing the LLC articles of organization form, filing the articles of organization, obtaining a certificate to show that your LLC is formally registered, and creating an LLC operating agreement.
Ultimately, whether an LLC is the right choice for your business depends on your specific needs and circumstances. It’s important to consult with legal and financial professionals to determine the best structure for your business.
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Are you a small business owner who has been asked if your business is an LLC and you don’t know what that means? Or maybe you’re an entrepreneur in the early stages of starting a new business, and your head is spinning with all the options from a sole proprietorship to an LLC to a corporation.
Read on to learn everything you need to know about an LLC and whether it’s the right choice.
What is an LLC?
A Limited Liability Company (LLC) is a business structure that provides owners with protections usually only available to corporations, but maintains the simplicity of a sole proprietorship.
This entity also provides transfer taxes, as it is managed through a separate entity that is not restricted to a specific number of shareholders and is not heavily regulated.
Related: How To Start A Limited Liability Company (LLC) | Entrepreneur
What are the benefits of an LLC?
There are benefits to every business structure. From a corporation, to general partnerships and sole proprietorships, each offers unique advantages.
The benefit of forming an LLC is that it takes the advantages of each business structure and combines them into one.
How can an LLC provide asset protection?
One of the main advantages of an LLC is that it protects your personal assets.
For any business debt or judgment your business may have, the owner has no personal liability. This ensures that your personal assets cannot be taken as payment as they are completely separate from the business.
Related: LLC Basics – Entrepreneur.com
What tax options does an LLC have?
An LLC offers more tax options than other business models.
For tax purposes, they are taxed as a sole proprietorship or as a partnership, depending on the management structure and the number of members involved in the company.
Members report their share of business income and expenses on their personal tax return and then pay personal income tax on the earnings.
Members who also work in the business are considered self-employed and must report this on their federal tax return and then pay self-employment tax on their share of the profits.
If the business does not want to be taxed as a sole proprietorship or partnership, it can also choose to be taxed as an S corporation (S-corp) or C corporation (C-corp).
TO c corp pays corporation tax, and owners pay taxes on their distributions. An S-corp is what’s known as a pass-through entity, which means it doesn’t pay corporate taxes, but each owner pays personal income tax on their share of the profits.
It is important to note that not all LLCs qualify for S-corp taxes, as they must meet certain IRS (Internal Revenue Service) Requirements.
A single member LLC can also be designated as a disregarded entity. What this means is that you will be ignored or disregarded in relation to federal income tax.
Related: The 5 Biggest Tax Differences Between an LLC and a Corporation | Entrepreneur
Does an LLC provide flexibility?
Since LLCs are not required by law to hold annual shareholder meetings or even require a board of directors, they provide greater flexibility than other business models.
Rather, members of an LLC are free to organize the company as they see fit and be managed by members, as administrative requirements like most corporations do not bind them.
Related: Choose your business structure | Entrepreneur
Does the LLC designation make your business more credible?
When you structure your business as an LLC, you receive exclusive rights to use your business name as a business entity.
Since most states do not allow a business to use an existing business name, you can create a public record of your name so that it is not available.
The LLC designation at the end of the company name can also lend credibility to a company.
Related: How To Structure A Single Member LLC | Entrepreneur
How are profits distributed in an LLC?
One of the main advantages of an LLC is that the members can decide how the profits are divided.
Corporations typically issue dividends and partnerships typically divide profits among partners, but LLC owners can choose how profits are divided.
Remember that the IRS has rules about special allocation of profits, and you may need to show proof of profit sharing or legitimate financial need to show that it is not simply an attempt to avoid paying taxes.
Are there disadvantages of an LLC?
While an LLC has specific benefits, it also has some notable drawbacks.
Profits are subject to high LLC tax
The earnings of an LLC are subject to social security and Medicare taxes. In some cases, the owners of an LLC may even end up paying more taxes than a corporation.
In addition, both the wages and profits of an LLC are subject to self-employment tax, which currently equals approximately 15.3%. Whereas with a corporation, only wages are taxed, not profits.
This handicap hits homeowners with a salary of less than $97,500 the most.
Related: Pros and cons of the LLC model | Entrepreneur
An LLC must immediately recognize its earnings
Unlike a corporation, LLC owners must recognize their earnings immediately.
A C-corp does not have to distribute its profits immediately to shareholders. This means that a C corporation is not always taxed on the profits of the company.
Since an LLC is not subject to double taxation, profits from the business are automatically included in the member’s actual income.
Related: Basic concepts of business structure | Configuration | Entrepreneur
There are fewer fringe benefits available
Employees who receive fringe benefits, such as group insurance, medical reimbursement, health insurance, and parking, must treat these benefits as taxable income with an LLC. This also applies to employees who own more than 2% of an S-corp.
On the other hand, employees of a C corporation who receive fringe benefits do not have to report them as taxable income on their tax return.
How to set up an LLC
There are seven steps you need to take to start an LLC.
There are different state law requirements from state to state, so it is recommended that you speak with a legal professional about the specific requirements where you live.
Choose a business name
The first step in starting an LLC is choosing your business name.
Not only do you need to choose a name that doesn’t exist yet, but your state may also have certain requirements that you must meet.
Related: How to name a company: 7 useful tips | Entrepreneur
Choose a registered agent
The next step is to choose a registered agent. A registered agent receives the official and legal documentation on behalf of the company. Once the registered agent receives these documents, he passes them on to the company.
The registered agent must be at least 18 years old. You are allowed to choose yourself or an employee. The primary requirement is that the agent must have an in-state address during typical business hours.
Related: 4 Best LLC Services of 2023 | Entrepreneur’s Guide
Obtain a copy of the LLC’s articles of organization form from your state
In most states, you will need to file a document called the Articles of Organization with the state agency that handles business filings to establish your LLC.
Each state has a specific form that it will use; some also call it a Training Certificate.
Complete the LLC Articles of Organization Form
Each state has specific requirements for people trying to create an LLC. Some of the typical information you may need to provide includes:
- The trade name.
- The main address of the company.
- The purpose of the business.
- How the LLC will be managed.
- The contact information of the registered agent.
- The duration of the LLC.
Once you have completed this form, at least one of the business owners will need to sign it.
Related: Ten Steps to Organizing an LLC | Entrepreneur
Filing the Articles of Organization
Be sure to thoroughly review the Articles of Organization form before submitting it.
You may also have to pay a filing fee, which differs from state to state.
Once your form has been approved, the Secretary of State’s office will issue you a certificate to show that your LLC is formally registered.
You can use this certificate to complete tasks like setting up a business bank account and registering for a tax identification number.
Related: Choose your business structure | Entrepreneur
Create an LLC Operating Agreement
Now that the state has approved it, it’s time to create an operating agreement.
An operating agreement outlines all the details of the financial, legal, and management rights to which all members of the LLC are entitled.
In particular, it includes how profits will be distributed, how members can leave the LLC, and who must provide capital.
You can create your operating agreement, especially if you are a one-member LLC. Hiring an attorney may be a good option for more complicated situations, such as multi-member LLCs.
Related: Why So Many LLC Operating Deals Fail | Entrepreneur
Keep your LLC active
Now that your LLC has been created, you need to keep it active.
This means that you need to make sure that you keep your business up to date with your status. This may include the LLC filing an annual report that keeps your business information up to date and paying an annual filing fee.
Related: Business – The Many Benefits of Forming an LLC | Entrepreneur
Start an LLC today
With benefits ranging from business flexibility, different tax options, and personal asset protection, creating an LLC could be the next step your business should take.
By following the steps above and consulting an attorney in your area, you will soon be able to run your own LLC and reap all of its benefits.
Verify Other entrepreneur articles for more information about LLC and other financial issues.
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