So, you want to start a business, and you're interested in creating an LLC. It's a big step that could set you on the path to success. But what is an LLC, and how do you set one up? Read on for the answers.
What is a limited liability company (LLC)?
A limited liability company is a flexible business structure that protects its members from personal financial liability. If your LLC owes a debt you cannot repay, creditors can only seek compensation from the LLC itself. Your personal financial assets are protected. An LLC also protects its members from liability if another member takes negligent or other harmful actions that result in a lawsuit.
As an LLC is its own legal entity, you need to open a business checking account to maintain separation from your personal assets. Unlike traditional corporations, LLCs do not need to appoint directors, nor do they have any requirements about how often their members must meet.
In an LLC's formation documents, members can decide how the LLC pays taxes. An LLC can pay taxes as a corporation, which subjects the company to state and federal corporate tax rules. You can also have the taxes pass through to the owners' personal income — meaning that the company pays no taxes, but each owner pays income tax on a percentage of the LLC’s earnings.
6 easy steps to set up an LLC
If you decide that an LLC is the best corporate structure for your business, then you'll need to know how to set one up. These steps involve choosing a name, choosing a registered agent, filing the formation documents and applying for an Employer Identification Number.
1. Choose a name for your business
A good business requires a good name, and you need to have one for your business when you register your LLC. Generally, this name must include the term LLC, L.L.C. or Limited Liability Company.
Before you settle on a name, you should perform an LLC name search. Use your state's business entity search tool to check whether somebody else has already claimed the name. Most (but not all) states have this search feature on their Secretary of State website.
Reserving a business name
While you can choose a business name at the time of registering an LLC, you might have come up with a great name before you're ready to apply. If you settle on a name before you have everything you need to register, you can choose to reserve a business name before you fill out an LLC application. All 50 states have a process for reserving a business name, which will temporarily prevent other businesses from claiming your desired name. The amount of time for which you can reserve a name varies by state.
If you've performed an LLC lookup and determined that nobody has claimed your name, then you can reserve it. Seek out your state's application for reserving a business name. You will have to fill out all the required information, pay the required filing fees and send it to the state. Some states allow you to file online or by email, but others require you to file by mail or fax.
Registering a trade name (DBA)
Generally, you don't have to file a trade name — also known as a fictitious business name, assumed name or Doing Business As (DBA) name — when you set up an LLC. When you form an LLC, you get to choose an official business name as part of the LLC application. However, by registering a trade name, you can do business under a name other than the one you registered.
One reason you might want to register a trade name is if you want to operate under a simpler name than your official business name. You might also have a name that you wanted to operate under but couldn't register as the official name — usually because the desired name is too close to another registered business name.
As with reserving a business name, the process of registering a trade name varies by state. Some states allow you to register the fictitious name with the same institution that you used to register your legal name. Others require fictitious names to be registered in the county where you plan to do business.
Registering a trademark
If you want to prevent other businesses from using your company's name or brand, then it pays to register a trademark. You can register a trademark with the relevant state agency for the state your business operates in, but that only protects you within that state's borders. If you want to retain your trademark across the U.S., then you need to register it with the U.S. Patent and Trademark Office (USPTO).
When you register a trademark with the USPTO, you must specify which goods and services the trademark will apply to. You will have to pay a filing fee of between $250 and $350 for each class of goods and services you specify. It will take between 12 and 18 months to register a trademark, and there's always the possibility that the USPTO will refuse your registration for legal reasons.
2. Assign a registered agent
Every LLC must have a registered agent — but what is a registered agent for an LLC? Simply put, a registered agent is an individual who will receive official mail on behalf of your business. This includes all documents, correspondence, notices, subpoenas and summons from government entities. This agent is responsible for communicating the contents of this mail to relevant individuals.
Any member of your LLC can be the registered agent, so long as they are over the age of 18, live in the same state that the business is registered in and can be reached during normal business hours. You can also hire an outside service to act as your LLC's registered agent.
3. Complete the LLC Articles of Organization form
One of the most important steps in setting up an LLC in every state is completing an Articles of Organization form. This form is available on each state's Secretary of State website or the website of the related business agency or bureau. While the requirements vary by state, they generally include:
- A company name that is different from all other LLCs and corporations in the state
- A physical address within the state
- A registered agent
- Each manager's name and business address
- A list of officers, such as CEO, president, secretary, treasurer, etc.
- The LLC's stated purpose or profession
- The name and address of all organizers
Every year, an LLC must file an annual report, also known as a statement of information. This report will update the governing agency about any changes made to the LLC's Articles of Organization. If a business entity fails to file an annual report, it will be dissolved.
4. File the Articles of Organization
Once you have completed your Articles of Organization, you must file them with the appropriate state agency and pay your state's filing fees. The organization varies by state but it’s usually the Secretary of State's office or a specific state's business agency.
The filing process is not standardized. While many states allow you to file your Articles of Organization online, some still require you to send the documents through the mail or even file them in person. Your application should also include an operating agreement.
5. Put together an operating agreement
When you register an LLC, you should also create and file an operating agreement. An LLC operating agreement is a document signed by all members of an LLC that governs all of its members. It outlines an LLC's rules, regulations and procedures.
An operating agreement stipulates the rights, obligations and duties of an LLC's members and specifies the percentage of ownership for each member. It also lays out how the business will handle its finances, such as where funds will be kept, when the company's financial year ends, how profits will be distributed, how expenses will be reimbursed and how capital can be contributed to the company.
When creating an operating agreement, you should specify whether your LLC will be taxed as a corporation or partnership. When taxed as a corporation, the business itself will pay taxes according to state and federal corporate tax rules. When taxed as a partnership, the business is subject to pass-through taxation. This means that the business itself doesn't pay taxes, but each member must claim their share of the business' income on their individual tax forms.
Operating agreements are legally binding and must comply with state and federal laws. Consider seeking legal advice and consulting with an accountant before creating or signing an operating agreement.
6. Apply for an EIN with the IRS
Most types of businesses must apply for an Employer Identification Number (EIN) with the IRS. The IRS uses these numbers for tax identification purposes. A single-member LLC does not require an EIN, but all multi-member LLCs require one.
Every EIN application requires the following information:
- The legal name of the business
- The trade name of the business (if applicable)
- The business address
- The name of the responsible party (the person who manages the business' funds and assets)
- The responsible party's Taxpayer Identification Number
- The type of entity (LLC, Sole Proprietorship, Partnership, etc.)
- The reason for applying
- The date the business started or was acquired
- The highest number of employees expected in the next year
- The principal activity of the business
Businesses located in the U.S. can apply for an EIN online for free. Businesses can also fill out Form SS-4 and send it to the IRS by fax or by mail. International applicants can apply by phone and answer questions verbally to receive an EIN.
The difference between LLCs and other entities
You now know how to start an LLC. However, you must also consider whether an LLC is the right business structure for you. While you already know what an LLC is, it’s important to compare LLCs with other business structures.
Sole proprietorship vs LLC
A sole proprietorship is a business owned and run by a single individual. It is the easiest business structure to form. While you can apply to officially register as a sole proprietor, you automatically have sole proprietor status if you do business on your own, such as through contract or gig work.
Legally, the government views the owner of a sole proprietorship and their business as the same entity. A social security number can even substitute for the sole proprietor's EIN on tax forms. As a result, a sole proprietor is responsible for all of their business' debts and liabilities.
In contrast, an LLC business is viewed as a separate entity from its owners. A creditor cannot force an LLC owner to use personal assets to pay back business debts. To obtain these protections, an individual can register as a single-member LLC.
S corp vs LLC
An S corporation, also known as a "closely held corporation," is a business structure that considers each of its members to be a shareholder. Like an LLC, an S corporation protects its shareholders from business liability. However, that's where the similarities end.
While an LLC can choose whether to be taxed as a corporation or as a partnership, S corporations only have one option. The S corporation does not pay taxes, but each shareholder must pay taxes on their earnings using their individual income tax returns.
S corporations have less flexible rules than LLCs. While there's no limit to how many members an LLC can have, an S corporation has a maximum limit of 100 shareholders. S corporations also have stricter rules regarding their governance. For example, an S corporation is required to have a board of directors, it must follow certain procedures for meetings and record-keeping, and only U.S. citizens can register as shareholders.
PLLC vs LLC
A PLLC is a professional limited liability company. It operates much like an LLC but is run by licensed professionals. The types of professionals who can form a PLLC vary by state but generally include doctors, dentists, optometrists, architects, accountants, lawyers and engineers.
PLLCs have many of the same benefits as LLCs. They offer the same flexible tax options, and they protect the assets of individual business owners from creditors. Also, individual owners are not liable for mistakes made by their partners.
The primary difference between PLLCs and LLCs centers around malpractice claims. Members of a PLLC are liable for any malpractice suit brought against them. This means that malpractice insurance is highly recommended for every PLLC member. However, a PLLC protects its members against malpractice suits brought against any other member of the PLLC.
Only 28 states and the District of Columbia recognize PLLCs. In most of these states, every member of a PLLC must be a licensed professional. A small minority, however, only require half of a PLLC's members to be licensed professionals.
Are you ready to start your business?
Starting an LLC, or any other type of business for that matter, requires preparation. Beginning a new venture can be exciting, but jumping in headfirst without taking preliminary steps only invites failure.
If you're a prospective business owner, set yourself up for success. Before registering your business, conduct market research to fully develop the idea behind your business. You should also determine the cost of doing business, write a business plan, secure funding and choose a business structure that fits your needs.