So you have a great business idea and you’re ready to get started on making it a reality. That’s awesome! One of the first big decisions you’ll need to make is what type of legal structure to form your business as. There are a few options – sole proprietorship, partnership, corporation, to name some of the most common.
But today we’re going to focus on one of the most popular structures for small businesses in the US – the limited liability company, or LLC. Nearly 4 million LLCs are formed in the US each year, and for good reason. LLCs offer business owners personal liability protection and tax flexibility in a relatively simple and inexpensive business structure.
Before we dive into the step-by-step process for how to form an LLC, let’s do a quick LLC overview.
An LLC is a business structure that sort of combines features of partnerships and corporations. Like a corporation, an LLC legally exists separately from its owners, who are called “members.” This gives members personal liability protection – the debts and liabilities of the LLC itself are separate from the personal assets of the members.
LLCs are also extremely flexible in how they are structured and managed. You can form a single member LLC with one owner, or a multi-member LLC with any number of members. Profits, losses, ownership percentages, voting rights, and management roles can be customized in an operating agreement.
And from a tax perspective, multi-member LLCs are treated like partnerships while single member LLCs are taxed like sole proprietorships. But unlike corporations, LLCs can choose how they want to be taxed by the IRS – as a sole proprietorship, partnership, S-corp or C-corp.
Curious how an LLC compares to other business structures like sole proprietorships and S-corps? We’ll do a detailed comparison later in this article.
Ready to move forward with forming your own LLC? The good news is this process is pretty straightforward and can usually be done in under a week. Just follow these seven steps:
You can form an LLC in any state, regardless of where you physically live or where your business will be located. Each state has its own rules and regulations for LLCs though, so this choice does matter. Most LLC owners form their business in the state where their company will be physically located and operating. This is usually the easiest and most affordable option.
You will still need to register or “foreign qualify” your LLC in other states where you’ll be conducting business activities. For example, if your LLC is formed in Texas but you open a storefront in Oklahoma, you would need to register as a foreign LLC with the state of Oklahoma.
When deciding where to form, compare the ongoing costs and compliance requirements of different states. Annual fees, taxes, and filing requirements can vary significantly. States like California and New York tend to be more expensive and labor-intensive for LLC maintenance. Low-cost options include Texas, Georgia, and Wyoming.
Naming your business might just be the most fun part of the whole LLC formation process! But there are a few rules you’ll need to follow:
– Your LLC name must be unique and distinguishable from other businesses in your state. Do a name search on your Secretary of State website before settling on a name.
– The name must indicate your business is an LLC, by including “Limited Liability Company”, “LLC”, “LC” or similar.
– Make sure your business name doesn’t infringe on any trademarks. Do a trademark search for the name you want before filing your articles of organization.
– Consider whether you want to operate under a different “doing business as” (DBA) name. You can form Bob’s LLC but do business as Bob’s Bagels.
Once you land on the perfect LLC name, you can temporarily reserve it in most states so no one else snatches it up before your file your paperwork.
One of the legal requirements for any LLC is that you designate a registered agent for your business. This is the person or company that will receive official documents and notices on behalf of your LLC.
This can be yourself as the business owner, but most LLCs choose to use a registered agent service. Having a third-party agent shields your personal address from public records. It also ensures someone reliable is available to receive time-sensitive legal papers if you’re out of town or can’t be reached.
An operating agreement outlines the governing rules, policies, member roles, ownership structure, voting procedures, and profit allocation for your LLC. This document is required by law for LLCs with multiple members, and highly recommended for single-member LLCs as well.
The operating agreement helps set clear expectations from the get-go and prevent disputes down the road. For multi-member LLCs, it’s especially critical to work out issues like ownership percentages, voting rights, member responsibilities, and profit splitting.
While you can draft your own agreement, it’s wise to have an attorney review it if you have multiple owners. Make sure important topics like transfer of ownership, adding new members, dissolving the LLC, and member buyout provisions are fully addressed.
To legally form your LLC, you must file articles of organization (sometimes called a certificate of formation) with your state. This document includes basic information about your LLC:
– The LLC’s name
– Your registered agent’s name and address
– Physical address of your LLC’s principal place of business
– Management structure – member-managed or manager-managed
– Who authorized forming the LLC (one of the members or an attorney)
– The nature of your LLC’s business
Most states allow you to submit your articles of organization online for a small filing fee, usually $50-$200 depending on the state. Approved articles will come back with your state file number – proof your LLC officially exists!
An employer identification number (EIN) is a unique tax ID number the IRS will use to identify your business. Think of it like the Social Security Number for your LLC.
You need an EIN to open a business bank account, hire employees, and file business tax returns. An EIN also further separates your business and personal finances.
Applying online at the IRS website only takes minutes, and there’s no filing fee. Once you have your EIN, open a dedicated business bank account in your LLC’s name. Never mix business and personal funds.
Most new LLCs need some combination of business licenses and permits before officially launching. Requirements vary based on your industry and location.
Some common examples include a sales tax permit, a general business license from your city or county, professional licenses mandated by your state, and food service permits for restaurants. Fail to get a required license, and your LLC could face hefty fines.
Check with your Secretary of State’s office and local county/city clerk to find out exactly which credentials your type of business needs. This should be done before your LLC starts operating.
Congratulations – forming your LLC is complete! But the work doesn’t stop there. On an ongoing basis, you must keep your LLC compliant with state laws and in good standing. This involves:
Filing an annual report – Most states require LLCs to submit a simple report each year with basic information like your principal address, registered agent, and managers. There is usually a small fee.
Paying franchise taxes – Even if your LLC isn’t doing any business, you may owe annual taxes just for having an LLC registered in that state. California charges LLCs a minimum $800 franchise tax, for example.
Maintaining a registered agent – To keep receiving important legal notices, you must continuously maintain a registered agent with a valid address on file with the state.
Stay on top of these recurring compliance tasks. If you miss state filing deadlines, your LLC could face suspension, fines, or even dissolution. Set calendar reminders so you always file taxes and reports on time.
Is an LLC the right choice for your new business? Or would a sole proprietorship, partnership, S-corp or C-corp better meet your needs? Let’s compare some of the key factors that distinguish LLCs from these other common entity types.
Sole proprietorships and partnerships offer the simplest business structures with the least paperwork. There’s no formal registration – you can just instantly start doing business.
But the owner(s) receive no personal liability protection. You and your personal belongings can be vulnerable if your business is sued or can’t pay its debts. For risky enterprises or those requiring substantial startup financing, an LLC is usually the safer choice.
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