Millions of startup businesses have been formed as Limited Liability Companies (LLCs). Businesses as diverse as restaurants, retail stores, online companies, and real estate have elected to be formed as LLCs.
In this article, I answer 10 of the most frequently asked questions about forming and operating an LLC, including what an LLC is.
1. What is an LLC?
An LLC is a popular structure for forming a company. LLCs, S corporations and C corporations are among the most popular business structures. LLCs have the benefit of providing limited liability protection for the owners of the business, similar to a corporation. This means that the owner of the LLC, if properly operated, should not be personally liable for the debts and obligations of the business.
This limited liability protection is also available in S corporations and C corporations, but not in sole proprietorships or general partnerships.
2. What are the tax benefits of LLCs?
An LLC can provide for “pass-through” tax treatment so that there is only one level of tax and it can avoid the double taxation found in C corporations. Only the owners of the LLC are taxed (unless a contrary tax election is made, and there is no tax at the LLC level. This is similar to the tax treatment for S corporations.
3. In what state should you form your LLC?
Because an LLC is formed by filing in accordance with the requirements of a state law, you have to decide what state you should organize in. Delaware is often chosen because of its well-developed state law. But in the vast majority of situations, you should organize the LLC in your home state to save on fees, filing obligations, and complexities.
4. What is the easiest way to form an LLC?
For simple LLCs (such as when there will be a single owner), the easiest way to form an LLC is to use an online business formation service to do the work, such as CorpNet.com, MyCorporation.com, or ZenBusiness.com. For more complicated LLCs (with multiple owners or complicated ownership or management/voting rights), a lawyer experienced in LLCs may be more appropriate.
5. What are the costs of forming an LLC?
Here are some typical costs for forming and operating an LLC:
- State filing fees—Range from $35 to $500 depending on the state.
- Fee for service provider to form your LLC—Many online sites have different programs to form an LLC with fees typically ranging from $100 to $500. If you use an attorney instead, the fees will likely be higher, depending on the complexity involved
- Annual franchise tax—The state will likely impose a minimum annual franchise tax, typically $100 to $800 per year.
- Registered agent fee—Every LLC must have a “registered agent for service of process” in the state where it is registered. This is an individual or company that agrees to accept legal documents on behalf of the LLC in case it is sued. While an employee, owner, or attorney can serve as the registered agent, many LLCs prefer to hire a professional registered agent company; the annual fee is typically $100 to $400.
- State report fee—In many states, an LLC is required to file a report (every year or every two years) with the Secretary of State, keeping the LLC’s information up-to-date. This is sometimes referred to as an “Annual Report” or “Statement of Information.” The fee to be paid for this filing usually ranges from $20 to $100.
- Business license fees—Depending on where your business is located and the type of business, your state, county, or city may require you to obtain a business license, with a cost typically of $50 to $100.
- Tax/accounting fees—An LLC will typically hire an accountant to prepare its required annual tax filing and produce the IRS K-1 statements that have to be given each year to the owners of the LLC.
6. What are the key documents involved in forming an LLC?
Here are the key LLC forms and documents:
- Articles of Organization—This is the document filed with the Secretary of State to officially form the LLC. It’s sometimes called a “Certificate of Organization” by the state. It is the equivalent of Articles of Incorporation for corporations.
- LLC Operating Agreement—This is the agreement among the owners of the LLC setting forth financial, capital contribution, management, voting, and other rights and responsibilities of the owners. Most lawyers and online services have a standard form of LLC Operating Agreement that can be tailored to your specific situation.
- Business license application—Business license applications may be required by your state, city, or county.
- Employee Identification Number—The IRS requires that you obtain an Employee Identification Number (EIN) for your LLC, which you can easily apply for online here. The IRS does not charge a fee for this.
- DBA—If you plan to operate the LLC under a name different than the business name on file with the state, you may need to file a DBA (“doing business as”) name form.
- Bank account forms—It’s important that your LLC has its own banking/checking account to separate the company’s funds from the personal funds of its owners. Banks will require certain forms to be completed before allowing an account to be opened, together with a copy of the LLC’s Articles of Organization to show it’s a legal entity.
7. What can I name my LLC?
There are multiple issues in picking an LLC name:
- The name typically needs to end with “LLC,” “Limited Liability Company,” or some permitted abbreviation thereof.
- The name must be distinguishable from all active foreign and domestic LLCs filed with the Secretary of State (in California, you can do a preliminary search of LLC names on record at sos.ca.gov).
- The name can’t contain some terms that may be prohibited by state law (such as “bank,” “trustee,” or “insurance company”).
- The name can’t contain the words “corporation,” “inc.”, “incorporated,” or “corp.” (to ensure that the LLC is not misconstrued as a corporation).
- You need to do a trademark search to ensure you aren’t violating another party’s trademark (check uspto.gov).
- You should conduct a thorough internet search on the proposed name to see if other companies’ use of the name could cause you problems.
- Don’t pick a name that could be limiting as you grow the business (such as “Oakland Tires, LLC”).
- Check on the availability of getting the “.com” domain name associated with the business (as opposed to “.org,” “.net,” or some other variant).
Picking a good name is not easy and obtaining the desired domain name you want will likely involve some meaningful cost if it is already owned by a third party. For more advice on this, see 10 Tips for Naming Your Startup Business.
8. How are LLCs owned and managed?
The owners of an LLC are called “members” as opposed to the owners of a corporation who are called “stockholders” or “shareholders.” A single-owner LLC will contain one member and own 100% of the LLC interests.
Ownership in an LLC typically entitles the owners to a percentage of the LLC’s profits, losses, and cash distributions, and a right to vote on certain business decisions of the LLC. This is all set forth in the LLC’s Operating Agreement.
The LLC can be managed by one managing member, a group of members, an outside manager, or by all the members, as you set forth in the Operating Agreement.
An LLC does not have a Board of Directors, which is required for corporations.
9. What is typically contained in an LLC Operating Agreement?
The LLC Operating Agreement sets forth the owners’ financial, management, and other rights and responsibilities. Here are some key issues that should be addressed in the LLC Operating Agreement:
- The amount of capital contributions made to the LLC by the members of the LLC, and when those contributions are required to be made.
- Any penalties or remedies if the capital contributions are not made.
- How profits and losses are to be split and cash distributed among the owners.
- Whether any members or class of securities of the LLC have preferences in distributions or on liquidation (akin to “preferred stock” in a corporation).
- Who will manage the LLC.
- How any officers will be appointed.
- Voting rights for major events like additional capital contributions or sale of the business.
- Indemnification protection for the managers running the business.
- Restrictions on transfer of LLC interests (the LLC interests are often referred to as “units”).
- Procedures for meetings of the members.
- Procedures for dissolution.
10. What are the principal disadvantages of an LLC?
Disadvantages include:
- Venture capitalists and other professional investors will likely not invest in an LLC, as they prefer investing in a C corporation.
- Transfers of ownership interests are more complicated than transfers of stock in a corporation.
- Some states will impose a minimum annual franchise tax, plus a tax on gross revenues over $250,000.
- For a multimember LLC, the LLC Operating Agreement needs to be carefully drafted.
- Additional accounting fees will be incurred to issue IRS K-1 forms annually.
- The owners of the LLC may have to pay self-employment taxes on the profits of the LLC.
- Since there is “pass-through” taxation, if the LLC shows a profit in a year, the owners will have to reflect their percentage interest in the profits as income in their individual tax returns, whether or not they have received any cash distributions.
- Issuing equity and employee options is more complicated in LLCs in comparison to corporations.
Should you form an LLC?
As discussed in this article, LLCs may be appropriate for simple businesses involving one owner or a small number of owners. But in more complicated situations, a C corporation or S corporation may be more appropriate.
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