Every business has some or other financial implications during its tenure. The appropriate legal form of business depends on the degree or severity of these implications. Sole proprietorship or partnership is easy to form and operate but the personal risk of the business owner (s) in operating these forms is unlimited. When the transactions and risks involved in a business is considerable, it is necessary to choose a form that provides protection from unlimited personal liability. Corporations and Limited Liability Companies offer the personal liability protection to its business owners.
If the primary objective of the business form is personal liability protection, LLC form will serve the purpose. Forming LLC or Corporation needs certain legal formalities to be complied with. However, corporations are high maintenance business forms. Unless the business owners do not foresee considerable growth or intend to take the business to the public, forming and maintaining a corporation is not worth the hassle. Another plus for forming LLC is in LLC Taxation. Corporations have to file an individual tax return as a legal entity or ‘person’ and pay state and federal taxes directly. Again, when the profits are distributed as dividend among the shareholders, they have to declare it as personal income and pay tax. Sort of double taxation. The members, as the business owners of an LLC is called, can elect to be taxed as sole proprietorship, partnership or even a corporation, whichever is most beneficial to them.
How to LLC formation, the state laws regulate the formation and operation of LLCs. Each state has different rules and procedures for incorporation or organization of an LLC. Refer to your state LLC regulations to understand the requirements for forming and operating LLC. In all states one basic requirement is filing the Articles of organization. The nomenclature may change in each state but the purpose is the same. An available valid name has to be chosen for your LLC. Then file the articles of organization in that name and provide all the information in the articles as required by the state. You need a person or entity with a local address to act as your registered agent and that person’s written consent to act so must be provided. Some states stipulate an Operating Agreement duly executed and signed by the proposed members as a part of the business registration process. Even otherwise, an operating agreement is beneficial to the business in many ways. It will provide clarity to business’s operational and organizational structure and a separate identity from that of the members. A publication of the intent to form the LLC may be required in some states.
Limited Liability Company is relatively a new form of legal business structure. Now all the 50 states allow Limited Liability Companies (LLC) to register as a business. The business owners of LLC are termed ‘members’. LLC can have single or multiple members. LLC is formed under the state statutes. There are variations in rules and regulations governing the formation and conduct of LLC in different states. LLC definition is that it provides the limited liability protection offered by a corporation with the operational flexibility of a partnership. LLC are not a tax classification for federal or state tax laws. LLC taxation can be according to the member’s choice. The members can elect to be taxed as a partnership, C or S Corporation.
The basic guidelines for how to LLC formation is
Name availability: Your LLC needs a name to operate under. You have to check whether the name you have chosen is actually available for use. The issue here is that the name you have chosen must not be identical to that of an existing business. Your option to check whether the name is in use is to consult your state’s agency handling LLC registrations or search online resources. The name must contain the words ‘Limited Liability Company’ or ‘LLC’ or such other abbreviations that conveys the company’s limited liability status. Some word or terms such as corporation, bank or insurance or others specified by your state are prohibited from being the part of a LLC name.
Articles of Organization: Some states call this as Certificate of Organization also. For an LLC to come into existence in any state, this document must be filed and the filing fee paid. The Articles or Certificate must contain all the critical information regarding the LLC.
- Proposed name and address of the LLC
- Name and addresses of all the initial members
- Name and address of the resident agent or agent of service of process.
- Purpose of LLC formation
- Business activity
- Membership interests (rights and responsibilities of the members)
The above information may vary with each state.
Operating Agreement: Only some states mandate that an LLC operating agreement also be filed along with the Articles. As a rule, this document is imperative in every LLC’s existence. It provides the LLC with individuality separate from its members. The basic information required is
- Membership interests
- Management policies
- Business ethics
- Membership transfer conditions
Public Notice: You have to issue a public notice on the intent to form you LLC. This is required in some states only.
If you are already operating a business as a sole owner and are wondering whether you need a proper legal structure for your expanding business, consider these. The recognized business structures are Sole Proprietorships, General or limited partnerships, C or S corporations and Limited Liability Companies. All these business structures have their inbuilt pros and cons. Adopting an appropriate legal structure for your business depends on many factors. The first step is to understand your business needs. If you are operating a small business without many risks or potential liabilities, a sole proprietorship is the most commonly used structure. If the business is run jointly by one or more persons, a general partnership will be suitable. Both these business structures are easy to form and operate and there are hardly any legal or statutory formalities to comply with except for employment and income tax filings.
If your business volume and activities are considerable, you need a sophisticated business structure. The Corporations (Inc.) and Limited Liability Companies (llc) are designed for conducting business with limited risks to the business owners. In a sole proprietorship or general partnership, the business owner’s personal risks are unlimited. The business owners and their personal properties are fully liable to settle business debts and obligations. Whereas, by forming a LLC or a Corporation, you limit your personal liability in business obligations. Corporations are generally used for medium or large scale businesses which involves high turnover and associated risks. Forming a corporation and maintaining it is comparatively expensive than other forms of business structure.
If you are a small business but has considerable risks or potential liabilities associated with your business forming an llc is the most appropriate thing to do. By forming an llc, you limit your personal liability for business obligations to a present amount. The legal and statutory formalities for forming an llc are simple and easy. Formation of Limited Liability Companies and Corporations are governed by state laws. The rules and regulations governing business may differ from state to state. The business registrations are usually handled by the Secretary of State’s office. You have to file an Articles of Organization stating the basic information of you and your business and pay a filing fee. Information required to be included in the Articles may vary in each state. Then you have to adopt a operating agreement for the LLC. The operating agreement helps in clearly stating the LLC’s business policies which will also provide a separate existence to the entity and the status of your limited liability. One of the best features of an LLC is the llc taxation. You can elect to be taxed as a partnership or a corporation as you wish or which is beneficial to you.
LLC taxation is no different from any other business entity taxation. In reality, llc definition does not have an individual tax classification at the Federal or State level. Limited Liability Company owners can elect to be classified in any of the other business entity tax classification convenient to them. A single owner LLC is by default classified and taxed as a sole proprietorship. Multiple owners LLC can elect to be taxed as a partnership or a corporation. If elected to be taxed as a partnership, the income from business should reflect in each partner’s tax returns. When taxed as a corporation, tax on the business income has to calculated and paid through 1120 form. In Federal and state taxation, the differences in LLC vs S Corp taxes are that LLC can elect to be taxed as convenient to the members and beneficial to the business, while the S Corp passes through it profits to its shareholders who in turn reflects that in their personal tax returns and pays taxes accordingly.
A single member Limited Liability company when elected to be taxed as a “disregarded entity” (which means the LLC has no separated existence from that of LLC owner for tax purposes) profit from active trade or business is subject to self employment tax. The single member should report the business income in a schedule C tax form and pay the self employment tax based on Schedule SE Tax form. Where the LLC is not engaged in active trade or business and only a passive source of income such as income from investments or deposits, no self employment tax is payable. When a multiple member LLC engaged in active trade or business elects to be taxed as a partnership, the partners pay self employment tax on their share of profits and report the business income through a 1065 form. In an LLC elected to be taxed as a corporation, no self employment taxes are applicable on amounts paid as wages to the members but such payments will be subject to payroll taxes.
Where the LLC is treated as a disregarded entity or a partnership for tax purposes, no payroll taxes are applicable to profits distributed to the members and where no employees are engaged in the business. In LLC’s treated a C Corporation for tax purposes, any amount paid to members other than profits are subject to payroll taxes. For finer details on LLC taxation, consulting a corporate law firm will be prudent. They will be able to guide you on the most beneficial way to be taxed based on your business activities and LLC operating agreement.
Starting a business as a Limited Liability Company in the United States is easy and convenient as the procedures involved are minimal and straightforward in their content. Limited Liability Companies or llc’s are the most suitable for small business entrepreneurs as they have the advantage of limited liability for the debts and action of the LLC as in a Corporation but with flexibility in management and pass through taxation.
Setting up llc depends on the statute of your state of domicile. Most states do not restrict ownership and an llc can be owned by a single or several individuals, other llc’s, corporations and even foreign entities. Though, business like banks, insurance companies or non-profit organizations generally cannot be set up as llc’s.
To form llc, the legal requirements and regulations of the state in which the llc is to be set up need to be complied with. Each state may have its own rules and regulations regarding the formation of Limited Liability Companies. The owners of an llc are termed as members rather than partners or share holders.
There are certain llc forms and documents for starting up a business in every state. The basic documents are an Operating agreement and Articles of Organization. The operating agreement is drawn up by the members which sets forth the functions of the business, members interest or investments, voting rights, profit/loss sharing ratio, management policies, rights and duties of members and the dissolution or termination conditions. Articles of Organization are the basic charter for your business to engage in a lawful business activity in the state of registration. It should contain all basic information about your business including but not limited to Name and principal place of business, nature of business, registered agent’s name and address, name and addresses of the principal officers and the know members of the entity. Some states term this as Certificate of Organization also.
Limited Liability Companies are not recognized as a classification for tax purposes. Llc taxation must be done as a recognized federal tax entity as that of a corporation, partnership or sole proprietorship. Members can elect to be taxed as any one of the recognized tax classifications by filing a form 8832 with the federal government. Llc taxation filing includes wage and tax statement (w-2, W-3) and Forms 941 to 944 if it has paid employees and 1040, 1065 or 1020 for profit or loss from business in accordance with the classification the business has elected to be taxed.
To Form LLC ‘s you just have to follow a few simple steps.
- Name Availability. The first thing that you’re going to want to do, so you don’t waste time with paperwork that doesn’t pan out, is check with the Secretary of State, in the state where your business is located, to make sure that someone else has not already taken your proposed business name. Most states give you an easy-to-use name search feature on their government site. I’ve come up with names that were so off-the-wall creative that I know where of my own creation (at least I thought) and then I’d check the state’s website and find out that they were already registered by someone else. No one wants to go through all the hassle of creating the LLC form or documentations for one business name and then realize after the fact that it’s taken. Step one should be to check the availability of the name that you’d like to use for your new business LLC.
- Articles of Organization. After you have verified with the state that your desired name is available for your Limited Liability Company, you’ll have to complete a very short form called articles of organization. Most states will accept this on one sheet of paper. You can usually find a sample form on your state’s website otherwise, just do a quick search online for “articles of organization templates”. Completing this portion of the limited liability formation process shouldn’t take you very long, especially if you are mirroring another entity that has already been formed; it is just a matter of changing names and addresses. After you are done preparing the articles then you’ll need to file them with your state and get their stamp of approval. This stamp will have a date, which is your official organization date and becomes very important if you ever need to prove the age of your entity.
- EIN. When you have completed your name search and gotten your state to date stamp your articles of organization, then you are ready to apply for your Employer Identification Number (EIN). An employer identification number is to a business, what a social security number is to a person. It’s simply an ID that the government uses to keep track of your business. Since each state might have several businesses with similar names, the federal government has to use numbers (that are not duplicated) in order to distinguish one business from another. Your EIN can be applied for online at IRS.gov. The application only takes 10 minutes and the number can be issued to you at the end of the application process. You will use this number for vendors, LLC taxation, banking and a host of other reason.
