If you ever decide to start a business, one of the first choices you will need to make is which type of business you hope to create. There are many different ways to structure your business, and one of the most common is a limited liability company (LLC).
Generally speaking, establishing an LLC is one of the easiest ways to protect yourself from future tax obligations and potential exposure to legal consequences (i.e., people suing you). Due to easy creation and accessible benefits, there are currently more than 20 million LLCs in the United States (that’s about one LLC for every 20 people).
Are you currently a small business owner interested in “making things official”? Well, then establishing an LLC might be your most straightforward path ahead. In this article, we will discuss the most important things you need to know about establishing an LLC, including what they are, the benefits they provide, and the many reasons you might consider establishing one of your own.
What is an LLC?
An LLC, which stands for limited liability company, is a specific business structure designed to limit the legal and financial liabilities held by the business owner(s). Generally speaking, an LLC is one of the simplest methods for establishing a business. LLCs can be used by small businesses (with just one person), as well as large businesses. They are used by enterprises that provide goods and services of every kind.
When establishing an LLC, you will need to select a state (probably your home state) to incorporate in. Once you have completed the necessary paperwork, you will have officially established a business entity that can buy property, make transactions, accrue debts, and engage in other business interactions.
An LLC does not directly pay taxes. However, once the profits from an LLC are passed on to the owner(s), the owner will usually need to pay income taxes.
When an LLC is created, it will usually be required to file formal articles of incorporation. Essentially, these articles are a formal declaration of how the LLC will be structured, who has the right to claim what, and who holds onto certain liabilities. Compared to other business structures, such as a corporation, LLCs are relatively easy and affordable to create.
What are the Benefits of Creating an LLC?
Compared to a sole proprietorship, which is often the precursor to an LLC, establishing a limited liability company is an excellent way to protect your personal assets and potentially limit other sources of liability, such as taxes. If you run into debt or legal issues, your business assets might be at risk, but your personal assets (generally) will remain protected. Establishing an LLC also makes it easier to accumulate capital and apply for loans.
Compared to other, generally more complex business entities, such as a corporation, LLCs require less paperwork and have lower filing costs. Depending on the state you set up the LLC in, the fee you might be required to pay for filing can be as low as $25 (Mississippi) or as high as $500 (Massachusetts).
Overall, establishing an LLC can be considered the simplest method for “formalizing” your business. This is why thousands of LLCs form each day across the United States.
In the real estate world, many buyers and investors form LLCs in order to purchase properties. Buying a home with an LLC comes with many benefits. For instance, buying through an LLC ensures that the LLC’s name, instead of the actual owners’ names appears in public records. That’s why, if you do a property search on Taylor Swift’s mega real estate empire, you might not find a lot of information, because the properties are shielded by LLCs.
Buying properties through LLCs also makes it easier from an investment perspective. The LLC structure makes it very easy to invest in properties with friends, family, and even just investors you’d like to form joint ventures with.
What are the Drawbacks of Creating an LLC?
Of course, as is the case with every business structure, establishing an LLC can also have its fair share of drawbacks. Depending on your business structure, you might view the creation of an LLC as an unnecessary step (especially if the filing fee is high). Many freelancers, independent contractors, and gig workers who operate with little to no assets or outside capital might prefer to work as sole proprietors.
In some cases (though not most), the owners of an LLC, known as “members,” might actually have to pay more money in taxes. These taxes can include franchise taxes, capital value taxes, renewal fees, and more. All 50 states have different protocols for how LLCs are regulated and taxed. In other words, it might be a good idea to speak to a lawyer from your state before you incorporate.
In other instances, forming an LLC might not be sufficient to address your business’s complex needs. If you are starting your business with one or more other people, for example, then you may want to consider incorporating as a formal partnership instead. Suppose your business will be using a lot of assets, seeking large amounts of outside financing, or operating internationally. In that case, you might want to consider establishing a corporation. In the United States, there are two main types of corporations: S corporations and C corporations.
What You Need to Create an LLC
The exact laws for creating an LLC vary by state. However, generally speaking, here is what you’ll need:
- Choose a formal name for your business (this name can be different than the name you use while operating)
- Choose a registered agent—someone who will be in charge of managing and accepting tax documents. In some states, you can be your own registered agent, even if you are not an attorney.
- Create articles of organization declaring the structure of your business and distribution of assets
- Create a corresponding operating agreement
- Obtain an employee identification number (EIN)
- File an LLC in the state you live or plan to operate in
In some cases, you might want to consider working with an attorney—this can help you avoid common legal liabilities.
Should I Consider Creating an LLC?
Ultimately, whether establishing an LLC is suitable for your business depends on many different factors. There are plenty of businesses that can easily justify the creation of an LLC, while others will likely prefer to go in a different direction.
By creating a detailed business plan, you’ll get a better picture of which kind of business structure will make the most sense for you. Which assets (and corresponding liabilities) will your business likely need? Who else will be involved in the business—will you have a partner, employees, contractors, or anyone else working with you? Furthermore, what are your biggest financial risks? How about opportunities for growth?
Answering these questions will make it easier to make a final decision. Additionally, keep in mind that just because you are creating an LLC today, that doesn’t mean you’ll need to continue operating as an LLC forever (converting to another structure is possible, though sometimes complicated).
Regardless of which direction you choose to end up going in, be sure to at least consider every available option.