Many small business owners choose to form an LLC (limited liability company) to take advantage of its legal and financial benefits. In fact, approximately 21.6 million registered LLCs are operating in the United States. Understanding those benefits, as well as the disadvantages of an LLC, are key topics to explore if you are in the process of deciding which business structure to use for your small business. Below we highlight the benefits and disadvantages of LLC formation and provide you with the six simple steps to register an LLC.
What is an LLC?
First, you might wonder, "What does LLC stand for?" A limited liability company, more commonly referred to simply as an LLC, is a business structure that provides its members with two key benefits:
- Pass-through taxation: In plain terms, this means that instead of your business being taxed twice, once at the personal level and once at the corporate level, you'll pay taxes on your business on your personal tax return.
- Limited liability protection: When you form an LLC, it is legally a separate entity from yourself and any co-owners. Meaning, that should your LLC incur debts and liabilities, banks and other creditors cannot seize your personal assets.
Benefits of forming an LLC
There are a number of benefits to operating as an LLC rather than as a sole proprietor or general partner, or forming a corporation. In addition to pass-through taxation and limited liability protection mentioned above, other benefits of LLC formation include:
- Flexible owner membership: An LLC can choose to be taxed as a sole proprietorship, partnership, S corporation, or C corporation, allowing you to select the most tax-efficient option for your circumstances.
- Simple management structure: Unlike corporations, LLCs do not have strict formalities, such as annual meetings or record-keeping requirements, which can be time-consuming and require extra planning.
- Sense of business credibility: The formal legal structure and limited liability protection provided by an LLC can convey stability and professionalism, and can help to build trust with customers, investors and more.
- Lesser compliance requirements: Compared to corporations, LLCs have fewer strict regulatory requirements like holding annual meetings or keeping detailed records.
Disadvantages of creating an LLC
While there are a few disadvantages to the formation of LLC companies, in general these are outweighed by the benefits. Here are the disadvantages of LLC formation:
- Additional costs versus sole proprietorships: The cost of forming an LLC may include state filing fees, the cost of obtaining an Employer Identification Number (EIN) from the IRS, as well as costs associated with business permits.
- Difficult to transfer LLC ownership: Before you decide to register your LLC, be aware that should you one day choose to transfer ownership, all other owners must agree, and even then, not all states allow LLC transferring.
How to Get an LLC
If you've decided that an LLC is the route you'll take for registering your business, there are a few steps you'll need to take:
- Choose a business name: The first step will be to register your unique business name in the state where you plan to do business. You’ll want to do a search to make sure no other business has your name. You can typically do this through your state’s Secretary of State website or other entity responsible for business registration in your state. In some states, you can pay a small fee to reserve your name for a period of time before filing your articles of organization.
- Designate a registered agent: The registered agent is the entity that you designate to receive official correspondence for the LLC. Most states will require the name and address of your registered agent when filing for articles of incorporation. You can fulfill this role on your own, but there are a number of third-party companies that provide this useful service. Your state will have a list of these companies available.
- File articles of organization: Filing articles of incorporation provides your state with basic information about your company. Once these are accepted by your state your LLC is a legal entity. You’ll need to supply details such as a business name, place of business and registered agent.
- Get an employer identification number (EIN): The EIN is the business equivalent of a social security number and is an IRS requirement for any business that operates as a corporation or partnership, or those that have employees. The requirement to get an EIN applies to LLCs because for federal tax purposes they're considered as either corporations or partnerships.
- Create an operating agreement: The operating agreement of your LLC should define the management structure of your business, including a breakdown of ownership and a description of how profits and losses are distributed. In many states, the operating agreement isn’t a requirement, but they are useful to have anyway.
- Establish a business checking account: Once your business is formed you’ll want to set up a separate business checking account for it to keep the business revenues and expenses separate from your personal finances. This is a critical step to ensure your personal assets remain separate from the business in the event a lawsuit is brought against your business. It’s also helpful in keeping your business and personal tax liabilities separate.
- Keep Your LLC Active: Having an LLC is not a “set it and forget it” solution. You need to ensure your business remains in good standing with your state. This could include filing annual reports, paying an annual filing fee, or reporting to your state unemployment commission.
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As you can see, there are very specific steps in creating an LLC, but they're not necessarily difficult, as long as you approach each of the steps in an organized and efficient manner. Taking the time and expense to create an LLC for your business provides significant liability protection and can also provide beneficial tax savings.