Before starting a Limited Liability Company (LLC) you will no doubt want to learn how much it costs to start one. LLC costs vary by state, industry and business structure but typically will include setup costs, filing fees, reserving a business name, licenses and permits. Read on to learn about what an LLC is, how much it costs to create an LLC, any additional expenses that may be incurred, how LLCs work and how they differ from other types of structures.
Limited liability company (LLC) explained
To learn what an LLC business is, it's helpful to start with its ownership structure. An LLC combines features of both corporations and partnerships. It is owned by one or more individuals, referred to as members.
Unlike LLC members, the sole proprietors or members of a partnership are personally responsible for all debts and liabilities the business incurs. On the other hand, an LLC’s members own shares but aren’t personally responsible for the company’s liabilities, and company profits aren’t taxed. Instead, members report their respective profits and losses on their tax returns.
You might understand LLCs better if you compare them to the other major business structures. Sole proprietorships are unincorporated businesses owned by a single individual. In partnerships, two or more individuals own the business. All owners share in the company's profits and liabilities. Corporations are like LLCs but have the added advantage of keeping the business separate so owners aren’t responsible for corporate debts. Nonprofit organizations provide benefits to the general public and enjoy tax-exempt status.
How LLCs work
To get an LLC up and running, members file paperwork outlining the company’s structure in the state where the business will operate. The paperwork identifies whether a member or a manager will manage the LLC. In a member-managed LLC, all the owners collectively decide on issues facing the company. In LLCs run by a manager, one person or a group of members holds decision-making authority. Managers can be professionals hired by the company or chosen by LLC members.
Decisions made in the operations of LLCs may include the following:
- Authorizing legally binding contracts
- Borrowing money on behalf of the LLC
- Hiring or firing employees
- Purchasing, selling or otherwise divesting the company of its assets
- Opening or closing business bank accounts
Member-managed firms allow all owners to be directly involved in company management. If the LLC has a manager in charge, the manager or management team makes the daily operating decisions. Having a manager for an LLC may be the best means of running companies with many members or investors to avoid the confusion that multiple voices can cause.
The advantages of forming an LLC
There are several benefits to an LLC structure. Here are some of the key advantages that members enjoy:
- Flexibility to operate as they desire, rather than having the limited authority common to corporations
- Protection from the business’s debt and legal liabilities (unless you co-sign for a loan for the business)
- No responsibility to pay company debt, as personal assets can’t be seized should the LLC default
The disadvantages of forming an LLC
However, there are some drawbacks to having an LLC. Some of the biggest disadvantages include:
- High costs, as paperwork is involved, which can mean greater legal fees
- Legal risks, as your LLC can be sued, and you could lose all company assets
- Inability to set up your LLC in perpetuity, as some states have limits on how long the company can operate and, therefore, whether your descendants will be able to take over
- Difficulty transferring ownership of shares
The tax implications
The IRS doesn’t accord LLCs a separate federal tax classification. Members determine their tax status. They can select for the LLC to be a corporation, partnership or sole proprietorship.
Members can also set up “pass-through” taxation, in which the company doesn’t pay corporate taxes. The income and expenses are instead accounted for in members’ personal tax returns. Owners pay personal income tax on profits.
State and federal taxes you can expect to pay on your LLC include:
- Income tax
- Business entity taxes
- Sales and use taxes
- Property tax
- Employer tax
- Payroll taxes
- Self-employment tax
- Excise, gross receipts, fuel, alcohol and franchise taxes
When it’s time to pay taxes, it may be hard to decide whether to file with EIN (employer identification number) or SSN (social security number).
Use your EIN if you want your income to be taxed separately from the business’s income. You may also use it if you want to declare EIN tax deductions set up for businesses.
Pay taxes with your social security number if you don’t mind business profits being viewed as your own taxable income. You may also want to use it if you need to shield your business assets from creditors.
If you choose to file with your EIN, it’s important to keep your income and expenses separate. To help with this, check out the best business checking accounts.
The documents involved
Check your state’s regulations since each state determines its own rules and the legal documents needed for LLCs. In general, be prepared to provide:
- EIN or SSN: These are used for official paperwork such as tax forms.
- Application for a business name: Once you’ve selected a business name, you will need to check with your secretary of state or corporation website for further procedures. Rules can vary, so use the state website where your business will be located.
- Articles of organization: When you want to establish an LLC, your state will require you to provide this document that essentially sets up your company. It’s often available on your secretary of state’s website.
Articles of organization
The articles of organization may also be called a certificate of organization or certificate of formation. These establish the responsibilities each member and the LLC have to each other. While the required information may vary by state, the articles usually include:
- Name of business
- Primary business address
- Purpose of business: This can be broadly or narrowly defined depending on the state. Some states are lenient. They will allow you to broadly state “to engage in business,” while others require specifics.
- Ownership: Include all members, their contact details and the share of the company each member holds.
- Management: This is a statement of whether the business is managed by members or a manager and includes the manager's contact details.
- Registered agent: This is someone who accepts all governmental and legal paperwork. They can be chosen from within the LLC or from outside companies offering registered agent services.
An operating or company agreement lists the rules your company adheres to. It also provides member rights and responsibilities. It identifies the company’s governance and usually includes:
- Name and address of LLC, registered agent, managers and members
- Members’ voting rights
- Date LLC was formed and how long it will last
- Profit and loss distribution
- Scheduled meeting dates and times
- Procedure to add or remove members
Some websites provide sample LLC operating agreements, but keep in mind that this is a legally binding document. You may find it worth the effort to run your document through legal channels.
Employer identification number (EIN)
The IRS set up EINs to pinpoint business entities and require LLCs with more than one member to use them. If you are the lone member of your LLC, your social security number will suffice.
You will need an EIN when:
- You have employees
- You use or sell imported chemicals
- You make, sell or use U.S.-mined coal, aviation kerosene or spend a lot of business time traveling roadways
- Your LLC gains new members
- You change your LLC to a corporation
Setup costs for an LCC vary depending on the state where the business will be located. In general, they include:
- Costs to create a business plan and operating agreement
- Fees for permits and licenses
- Filing fees
- Equipment and supply costs
- Marketing costs
- Rent and utility bills
Of course, there will be other costs depending on your type of business. Consider ongoing costs.
You can deduct some costs of setting up an LLC from your federal income tax. At the time of writing this article, the IRS limits LLC deductions to $5,000, and you can get another $5,000 deduction for organizational expenses.
Governmental agencies charge filing fees to process certain documents. These include documents required for LLCs. One-time filing fees vary according to the state where you file the papers, but they typically range from $50 to $500.
Reserving an LLC name
Selecting a business name can be a monumental decision. Search online to see if your chosen name is available. Reserve the name on your secretary of state website. Some websites will run an LLC lookup to see if the name is available and will reserve it for you.
Reserving a name isn’t the same as registering it. When you reserve a name, the state will hold it for a length of time, usually 120 days.
If you’ve decided on what to call your LLC, it may be worth educating yourself on how to trademark a name to protect it in the long term.
Licenses and permits
States usually set license and permit requirements. You may also be required to get federal licenses. Most states require LLCs to obtain business licenses if they engage in:
- Dry cleaning
- Electrical work
- Food handling
Other licenses and permits may be required. For example, you may need home occupancy permits and premise permits for things like signage and elevators.
You need federal business licenses for businesses that involve:
- Alcohol manufacturing, importing or selling
- Commercial fisheries, fishing and wildlife
- Firearms, ammunition and explosives
- Mining or drilling activities
- Nuclear energy
- Radio and television
You may likewise need additional LLC licenses and permits, such as:
- Doing business as (DBAs)
- Licenses for hotels and construction
- Professional licenses
Check the Small Business Administration’s website for details. You may benefit by applying for licenses under the SBA’s regulations.
LLC vs sole proprietorship
Sole proprietorships are another type of business structure that can prove worthwhile if you’re just starting. Sole proprietors are individuals who hold total control over their companies. This type of business is relatively easy to start, but the business owner is personally liable for any debts and liabilities incurred. This means that when you own a sole proprietorship, business, legal or financial matters may arise, which can cause you to lose personal assets.
An LLC may be a better choice if you need to keep business matters separate from your private affairs. An LLC has its own legal identity, keeping business and personal assets separate. Should a legal or financial matter arise, your private assets can’t be seized.
With an LLC, your business can expand as your business grows. You can legally invite investors or business partners to join your business, but this isn't possible in a sole proprietorship.
LLC vs partnership
A partnership isn’t a legal identity of its own. The owners share the company’s legal and financial obligations. Any debts or legal actions against the partnership can be made against the partners. An LLC offers limited liability protection against any legal activity or debt the business incurs.
Of course, there are always taxes to consider. Members report profits on their personal tax returns if they own an LLC or partnership. However, LLC members can elect to be taxed like an S Corp, allowing themselves to be treated like employees. In so doing, wages are subject to self-employment taxes, and the remaining profits aren’t eaten by Social Security or Medicare taxes.
A partnership requires at least two members. It takes just one individual to register a business as an LLC.
Is an LLC required to legally run a business?
You do not need to register your business as an LLC to run legally, although there are good reasons for doing so. If you don't register as an LLC, you will either run as a sole proprietorship or a partnership. While this is easy and won't require many startup or filing costs, there are some limitations.
You may face high personal liability risks by choosing not to register as an LLC. Additionally, this limits your ability to grow since LLCs are more highly recognized in the business world.
Is a corporation better than an LLC?
An LLC offers more flexibility than a corporation. An LLC can be ideal for a business you manage yourself. Alternatively, a corporation can be better if you need outside investors, ownership changes or potential tax benefits.
However, corporations can be subject to double taxation. This is when both the corporation and shareholders pay taxes on profits or dividends. They can also be pricey to set up.
Start your own business today
Setting up a business requires time, money and hard work. The cost of setting up an LLC is only one consideration. You must take into account several factors before deciding on a sole proprietorship, partnership, corporation or LLC. You will also want to take other important steps when starting a business, whether it's finding the best small business loans or researching and marketing to your customers. When you understand and implement all these factors, you will be better prepared to succeed in today’s marketplace.