Limited Liability Companies (LLC) have become a popular way for business owners to increase their market power, but there are also some LLC requirements that you need to keep in mind.
You must understand how an LLC is different from sole proprietorships and corporations, as well as the steps necessary to set an LLC up. Read our article and find the information that you need.
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What Is an LLC?
A Limited Liability Company (commonly referred to as an LLC) is a business structure that offers pass-through taxation and limited liability protection. Usually, a limited liability company is changed from a sole proprietorship (disregarded entity), but it can also be set up as the first business.
Similar to corporations, limited liability companies are business entities that are separate from the owners. As a result, in case a business goes through debt, bankruptcy, or any form of liability, the business owner cannot be held personally responsible.
This way, their personal assets cannot be seized. In case the business goes bad, the only asset that may be seized is the business business account, or property strictly related to the business. It is always recommended to open a new business account specifically for your LLC. In fact, you could begin to open a new bank account without an LLC.
Benefits of Setting Up an LLC
There are various reasons why most people prefer setting up an LLC rather than a sole proprietorship. Here are the most important LLC benefits:
Members Receive Limited Liability
When you are a sole proprietor, your business and your own person represent the same entity. This means that if you were to go into business debts or you are subjected to personal liability, the creditors have all the rights to seize your personal assets (savings account, home, etc.)
However, as the owner of an LLC, you do not have this fear. Your business structure and your own person are held separately. Unless you are subject to piercing the corporate veil, your assets cannot be touched. The only assets that may be potentially seized are those related to the business directly. You'd need an LLC for personal liability protection.
Pass-Through Tax Treatment
Sole proprietors and owners of corporations may have quite a lot to handle when tax season comes around the corner. However, with a limited liability company, you get something called a "pass-through taxation."
With pass-through taxation, business income or losses incurred are "passed through" to the business owner, being reported on their own personal income tax return.
If your LLC has taxes due, they are paid on an individual level. This is unlike most corporations, which are taxed at a business entity level and end up paying more during tax season.
More Credibility
If you open a sole proprietorship or run a partnership, you get a certain degree of credibility - but generally, that is not enough. However, LLCs are much higher on the "food chain," which means they are seen as the most powerful and reliable option. If you create an LLC, you will be more likely to establish credibility among your clients and your partners.
Fewer Compliance Requirements
The state imposes fewer ongoing formalities and imposed compliance requirements as compared to a general partnership, sole proprietorships, or corporations. This means that you will have fewer headaches when it comes to setting up your business and keeping it running.
Flexible Memberships
Members within an LLC can be anything from partnerships, individuals, corporations, or trusts - and when it comes to the numbers of members, there is no limit for that. There are also fewer limitations in terms of memberships.
For example, S-corporations have more limitations when it comes to who can be a shareholder and you also get a maximum limit for that. When you form an LLC, you won't be held back by these limitations.
Better Management Structure
When you set up a limited liability company (LLC), you get a better management structure as compared to a corporation, for example. An LLC is member-managed, and you can have anyone from your company manage it.
This is different from corporations, where everything is managed by a board of directors. This means that for corporations, you do not necessarily have to be a shareholder, as long as you are part of the board. LLCs gives you more power to oversee your own business.
Read our resource on the disadvantages of an LLC so you can make the right decision.
What Are the Requirements of an LLC?
Before moving onto the requirements of an LLC, you must understand the difference between what is "required" and what is "needed."
"Required legal documents are those that are mandated by the state law, and without which you cannot proceed with your business. The "needed" documents aren't mandated by state law, but it's highly recommended for every business to have if they wish to avoid any legal complications in the future.
Every LLC requires you to file a Certificate of Organization form (also referred to as Articles of Organization). The Articles of Organization serve as proof of your LLC within the state. When filing your Articles of Organization form, don't forget that you have a filing fee to pay for as well.
You also need an Operating Agreement when you set up an LLC. It is not mandated by the state, but it can prove very helpful for federal tax purposes. It will provide a blueprint on how your legal entity will be managed.
You will also need an Employer Identification Number (EIN) given by the Internal Revenue Service, as well as a business license. Unlike disregarded entities, you cannot bypass these kinds of legal documents anymore. You may also need to get a zoning permit, to ensure you are functioning within the requirements of the area.
Depending on the state that you are in, there might be some slight differences. For one, the filing fees may be different, so you might want to check with the laws in your state. This is where hiring a law firm can come quite in handy.
How Do I Establish an LLC?
Establishing an LLC has some standard steps that everyone needs to go through. They are not necessarily difficult, but you may have to employ the help of some legal services. Contact a law firm so that they can assist you with the legal documents.
That being said, in order to set up an LLC, you will have to go through the following steps:
Choose a Name for Your LLC
Obviously, the first thing you should do when you are setting up an LLC is to choose a name for it. Bear in mind that there are certain requirements that you need to respect, which includes:
- The name needs to be original
- It needs to end with Limited Liability Company or LLC
- It should not have any restricted or forbidden terms unless you were specifically authorized to use that term
You may need to check your state's LLC database to see whether there any other companies that use the name you want or not. Once you have found a name that works for you, you may register it with your LLC formation documents (i.e., your Articles of Organization).
Appoint a Registered Agent
A registered agent is a connection between your limited liability company and the government. The job of a registered agent is to handle the legal work, potential filing fees, or any other legal aspect.
Bear in mind that when you form an LLC, small business owners and registered agents alike must be residents in the state they are operating in. Moreover, they should be able to provide a legal physical address.
As the owner of the LLC, you may choose to do this work yourself or have other members do it for you instead, provided they have a fair share of legal knowledge.
If they don't, you might hire the legal services of a law firm, or you may opt for some registered agent services. This way, you will be certain that the person doing the job is actually a professional.
Decide on the Management
Depending on the LLC that you want to set up, you may choose for it to be member-managed or manager-managed. For the most part, most LLCs choose to be managed by their own members.
However, depending on the level of knowledge or preferences, you may also have an outside entity managing your LLC - something like a board of directors. The key decisions for the LLC will be voted on by the managers.
Publish a Public Notice
This is not mandatory in every state, which is why you may want to check with your potential registered agent or your attorney. Depending on the state where you are starting your limited liability company (LLC), you may have to publish a public notice in your local newspaper before you officially form an LLC.
Once you have published it, you must attach an affidavit to your legal documents at the filing office. Seek the help of your local newspaper to do this step, as they are likely familiar with the whole process already.
File the Articles of Organization
At this point, you have all the required legal paperwork in hand, so it is time to officialize the business. The Articles of Organization represent a type of legal document that will offer your state the main information about your LLC.
This basic information will include:
- The names and signatures of the LLC owners. If you are forming a single-member LLC structure, only your name will be required.
- The name and address of your LLC
- The name and address of your appointed registered agent
The documents for your LLC must be filed at the Secretary of State or an affiliated office. You can do so by fax, or by traditional mail as well. Depending on the state, you may also have a filing fee to handle, which can be anything between $40 and $900.
Once the form has been approved, you will receive a certificate that acknowledges the existence of your LLC. You will become an official business entity.
File Your Annual Reports and Pay the Fees
Depending on the state, when you form an LLC, you need to file annual reports. Depending on the case, you may also have to pay an annual filing fee.
Some states do not need you to pay any fees when you file annual reports. However, other states such as California have you filing an annual LLC tax of $800. You may also have to pay other income fees if your profits go past certain stages.
It's a good idea to always stay informed on this matter. Your registered agent should be able to handle these matters based in the Internal Revenue Code, or you may find them yourself on the IRS website.
Read more on the best states to form an LLC.
Obtain Licenses and Permits
Depending on the location of your business, when you form an LLC, you may also have to obtain certain licenses and permits. For instance, if you plan on running your LLC business from home, you must make sure that the zoning administration permits that.
You may also need to get a business license alongside the permit, but once more, this differs from state to state. You might want to check with the Small Business Administration of the United States for the necessary information.
Create an LLC Operating Agreement
While not every state requires an operating agreement, it is still highly recommended that you form one. The operating agreement will be in charge of setting the internal rules of your LLC.
It can be as complex as the LLC owner wants it to, but the more detailed it is, the better it will serve you in the future. This will present any potential disputes between you and the other LLC members.
An operating agreement can cover multiple clauses, including but not limited to:
- What voting power do the members have?
- Rights and responsibilities of every member
- The management structure of the LLC
- Loss and Profit Distribution to the members
- The manner in which all meetings and votes will be held
An operating agreement is highly convenient because it allows you to tailor the business to your liking. It also provides a list of detailed information right from the very start. For example, if you want to close your LLC, you can include the guidelines or rules for how the assets should be distributed. It strengthens limited liability and helps avoid conflict simply because every member knows exactly what to expect.
The Bottom Line
Forming an LLC may have its complications, from business filings to providing an annual report for your profits. Despite the legal papers that you will have to handle, it is a good standing type of company. When you are deciding to incorporate or LLC, make sure you weigh out all the pros and cons. It is well trusted among clients, and the tax benefits will bring you a lot of profit.
