Starting a business can be a very exciting time, as well as stressful and overwhelming. Many entrepreneurs opt to form an LLC when setting up the business, and while it can be a great choice for some, it’s not always the best option for all.
There are. Many factors that need to be considered. In an effort to help collect some opinions and reasoning, I reached out to several experts, who have all shared information regarding the ins and outs of LLC formation, as well as what you need to consider before filing.
1. Ford W. Harmon, Maddrey PLLC
The first thing to be aware of with an LLC is that it is a creature of state law, not federal law. While many states have similar laws, an analysis of the law of the state in question is going to be relevant as there can be some significant differences. Without knowing what state is being considered, it is difficult to go into specifics about a particular LLC. For example, in Texas a 100 percent veteran-owned LLC would be eligible to waive the filing fee for forming the entity. I am not aware of what other states may have similar practices.
However, there are some general, big picture tips or pieces of information that should be made known. One concept deals with federal tax status of an LLC. The IRS has various classifications for entities for taxation purposes and LLC is not one of them. Instead, an LLC is going to be taxed under one of the entity types that exist in the eyes of the IRS and relevant federal law.
If an LLC has a single member, it will generally be counted as a disregarded entity by the IRS, unless the LLC opts to be taxed as a corporation (it can opt to be taxed as a C-corporation or an S-corporation — but it can only be an S-corporation if it meets certain requirements, including being owned by individuals and not owned by other entities).
If an LLC has more than one member, the default IRS rule is that it will be taxed as a partnership (with one exception being an LLC owned by two people who are also spouses and who are forming the company in a community property state, in which case the LLC can choose to have the default rule of disregarded entity or partnership apply). Just as if there were a single member, the LLC can generally opt to be taxed as a C-corporation or S-corporation (subject to the same S-corporation requirements).
All of this tax information will be entered when you get an EIN (employer identification number) from the IRS. This is something that should be done soon after the LLC is filed because there are certain timeframes within which you are limited to making choices as to the LLC’s tax status. It would be wise to have an accountant or other tax professional ensure that you have structured your taxes properly.
Another important piece of information for those starting LLCs that can be overlooked is the address used as the company’s registered agent and/or registered office. This is the official address of the business in the eyes of the state. This means that if the state has a tax issue or if a third-party is going to file a law suit, this is the address where official mail and service of process will occur. Many people choose to list their own addresses as the registered office and themselves as the registered agent. If an LLC is served at the address on file with the state, which happens to be the home address of the owner(s), and the LLC does not file a response within a given amount of time (usually no longer than a month), then the LLC could have a default judgment entered against it, and essentially automatically lose the law suit. Therefore, it is key to update the address if you are to use your own, but it is recommended that you use a third-party service provider so that you shift the burden of keeping track of your mail to another party.
2. Deborah Sweeney, MyCorporation
Although many states do not require LLCs to draft operating agreements, I would absolutely advocate in favor of doing so. Your operating agreement ultimately determines the way your LLC is run. It contains comprehensive information about the rights and responsibilities of its members, ownership rights, allocation of profits and losses, plans for gaining and losing members, and outlines what to do in the event of a business dissolution. Operating agreements are also legally binding. So, if issues come up between members that leave you concerned about your personal liability, this agreement will allow the court to recognize your company as a legitimate LLC. They will respect the document, allowing its members to make formal decisions concerning the business.
3. Andrew Contiguglia, Contiguglia Law Firm
Over the years, I have found that the limited liability company (LLC) has become the go to entity for small business owners and entrepreneurs. Overall, the business entity is easy to form and easy to maintain, making it very popular among entrepreneurs and small business owners. A properly structured LLC offers its members (the owners of an LLC, like a shareholder in a corporation) the pass through federal tax treatment of a partnership, while still protecting its members from personal liability for the obligations of the business. The nice thing about an LLC is the members have no personal liability for the obligations of it. However, the members will still maintain personal liability for their individual acts and omissions in connection with the LLCs business. From a managerial standpoint, an LLC protects its members much like a corporation does with its directors and officers.
Formation of an LLC is an easy endeavor. It requires two principal documents. The first document, referred to as the Articles of Organization in most states, or the Certificate of Formation in Delaware, is filed with the Secretary of State office in the state the company decides to be organized. Rarely are there tax advantages to filing in one state over another, although there can be. The best thing an LLC owner can do is check with his or her tax advisor to see if organizing the company in one state versus another state provides any tax advantages. In some circumstances, it might.
The second principle document for an LLC is its Operating Agreement, which closely resembles a partnership agreement for a partnership. The operating agreement identifies how the LLC will be managed by its members, or its manager. Basically, it’s the governing contract for the LLC, defining the financial obligations of its members, and how profits, losses and distributions will be shared. As with other business entities, this operating agreement can be tailored to meet the needs of each individual LLC.
Nowadays, access to legal forms is abundant online. Organizations like rocket lawyer, LegalZoom, and others, litter the Internet with boilerplate documents, enticing young entrepreneurs and business owners to cut corners. While a form agreement is better than no agreement, boilerplate documents should be avoided because of the specialized needs of each individual LLC. Ideally, the members of an LLC should work with one another to define the relationship and fashion an agreement that meets their particular goals and ambitions. This cannot be accomplished with a boilerplate agreement.
The best practice is to take the time and work out an agreement that identifies and protects the needs of the members along with the needs of the company. Business owners looking to use legal forms from companies like Legal Zoom or Rocket Matter, need to make sure they understand the true nature of what you they are agreeing to. An operating agreement is a contract after all. Not taking the time to understand the obligations created by a form can be extremely detrimental to the business relationships people are trying to create. In the end, its all about building a relationship between the owners of the business.
An LLC does have some limitations. For example, it’s not a good business entity if its members are seeking financing by venture capital funds. In such circumstances, there are tax restrictions on the funds’ tax-exempt partners. However, an LLC can be attractive in circumstances where the business is financed by corporate investors, and individuals, because it allows for the pass-through of passive losses if the LLC has a loss at the end of its tax year.
Generally, an LLC is the business entity of choice for startup companies and entrepreneurs because it’s able to pass through its losses to the investors. This is a great benefit while still offering the members of the LLC the same liability protection as offered by Corporation. Also, an LLC can have a corporation or a partnership as one of its members. This is not available for an S-corporation. Also, it is not subject to any other limitations that apply to S-corporations. Last, losses can be specifically allocated entirely to the cash investors. While, conversely, in an S-corporation, the losses are allocated to all the owners based on their share of ownership.
4. Warwick Carter, Warwick Carter Advisors, LLC
Limited Liability Companies (LLCs) are very easy to set up. They can be created in a matter of minutes over the internet. You simply need to select which state law you want and find a company that offers a service to create an LLC for you in that state. In Delaware, which is a very popular jurisdiction for LLCs, Delaware Registered Agent will prepare a simple LLC operating agreement and register your LLC with the Delaware Division of Corporations. There is a $90 filing fee to set up the LLC and an ongoing maintenance fee of $180. Delaware also charges an annual franchise tax on LLCs of $300. Other states may be cheaper.
Of course, more sophisticated planning is possible and some individuals choose to have their LLC documents drafted by attorneys. But the basics are very easy and can be done online.
Things to watch out for:
- Is the name you want to use available? You can run a name check to make sure the business name you want to use is available. You also can reserve the name beforehand if you aren’t ready to form the LLC yet.
- After creating your LLC, obtain an Employer Identification Number (EIN) from the IRS. This can be done easily online for no fee.
- Are you forming a single member LLC? If so, the LLC can be disregarded for income tax purposes so that all income and deductions of the LLC is reported on your personal tax return. Review the various tax options before you make your selection.
- Talk to your accountant about whether profits from your LLC’s business are “qualified business income” and may be partially deductible under the new tax rule for businesses (Section 199A of the Tax Code).
- If you formed your LLC in one state, such as Delaware, but are operating in another state, you may need it register the LLC in that other state and pay another tax or fee.
- If your LLC is going to be selling goods or services, watch out for state sales and use taxes. You should carefully research whether your activities are subject to sales and use tax and register the appropriate state. There are online services like Tax Jar that can help you figure it out. You should also consult the state taxing authority’s web site.
- An LLC is a legal entity. You should be sure to use the full legal name whenever the LLC is being referred to publicly or in any kind of business situation or transaction. That way you can get the protections that the LLC offers you.
- If you are setting up an LLC, it should have its own bank account. You should not co-mingle the LLC’s funds with your own. You may take a draw or a salary from the LLC, as your share of compensation, in accordance with your LLC agreement.
5. Erin K. Jackson, Jackson LLP
I’m a small healthcare business attorney and there are a few tips that I dispense frequently to clients:
- Ask yourself why you want an LLC. It’s not typically a requirement for engaging in the work your business will perform, and it requires legal and tax upkeep. Consider whether your money would be better spent purchasing more insurance and conducting business as a sole proprietor or partnership.
- Check the availability of your business name, and then hold your breath. The state’s business office — usually the secretary of state — will be the final arbiter of whether your business name is available, but you can usually perform some checks on their website to evaluate its availability. If it’s too close to an existing name, they may deny it, so keep an open mind until you receive the paperwork back.
- Have an attorney create your LLC. DIY lawyers frequently miss the nuances of their professional rules or the State’s requirements, and it creates headache, additional expense, and extra work down the road when it needs to be fixed. For example, I recently helped a therapist who had created a C-corporation himself for his therapy practice. If he’d instead hired me to help out, I could have told him that his professional licensing board won’t allow him to register as a C-corporation and that he instead needed to create an LLC or a professional corporation. He ultimately hired me to dissolve his first company and reestablish a new company, which was much pricier than if he’d hired me to begin with.
6. James M. Wilson, Wilson Law Group, PLC
LLCs have become the predominant business entity over the 25 years of my practice representing small businesses. I always start my discussion of the LLC by comparing the size of the Virginia code that cover corporations with the much, much smaller size of the code that covers LLCs, demonstrating that the majority of the “rules” that govern an LLC are of the members’ making, not the law. I advise them to think hard on the various decisions they need to make at the very first meeting because it is all academic at that point, no money involved, that they will be objective. But as soon as money is involved their thought processes are swayed by money.
I explain to them that although the rules that govern corporations that they may be somewhat familiar with do not govern their LLC, but those rules or a variation of those rules are probably good guidance for selecting the governance rules for their LLC. With any entity formation, but especially with an LLC, I discuss what happens with the LLC if one of the members dies and why, now, when no one is close to death is a good time to sort out what each “surviving” member would like the result to be if the any of the other members were to die. Usually heads will start spinning at this point, so I start suggesting what I have recommended before and we start picking members off one-by-one and imagining what the result will be to the surviving members and how that result will be handled economically by the business and the other members.
Another area that often comes up is whether to be member-managed or manager-managed. Usually if left to themselves, members will pick to be member-managed and I have to point out that as fair and democratic as that might seem, it is a practical nightmare for day-to-day operations if all members have to weigh in on every decision. I explain that a manager who has sufficient authority to run daily operations is the most efficient way to do it with member approval being required to approve “big” decisions, anything greater than the manager’s authority. When I get resistance to the manager-managed style of running an LLC, I ask if they really want to have all members required to sign a check for the company because spending money is part of managing, so a member-managed LLC could very well require all members signing all forms of spending money from contracts to checks.
In my experience, it is usually pretty easy to convince LLC members that they do not want to be member-managed and that one among them ought to be trust-worthy enough to manage daily events.
7. Will Pylant, Martinson & Beason, PC
Have you recently started a business or has the idea crossed your mind? If so, the new tax law and favorable economic conditions make now a great time to take that jump and open your own shop. Under the new tax law, certain pass-through taxation entities may be entitled to a 20% deduction for qualified business income. Here are some best practices for starting your own business to consider.
- Keep LLC funds separate from personal funds: Your personal finances should never be co-mingled with the funds of your business. By setting up an LLC, you limit your own personal liability. However, skilled trial attorneys can ‘pierce’ the corporate veil when funds are comingled. By operating your personal finances separate from your business, you ensure protection.
- Document capital contributions and initial expenses: Let’s say you decide to put $1,000 towards your new business and your friends decide to contribute $500 each. These capital contributions should be recorded in writing as the start of good corporate books. Capital contributions, along with ownership percentages, should be clearly recorded. The funds you expend in setting up the LLC, such as legal and accounting fees, should also be documented. These documented expenses may become relevant at tax time. They should be reflected in the corporate books as a matter of course.
- Sign documents in your LLCs name — not your own name: This concept is closely related to keeping funds separate. One of the main benefits of an LLC is creating limited liability for the owners of the LLC. The LLC should be treated as a separate entity. When you sign documents, such as leases and contracts, in your own name, you may be exposing yourself to personal liability. Some banks may require you to personally guarantee notes and lines of credit. But to the largest extent possible, use the LLCs name, not your own.
- Carefully review your operating agreement and follow it: Many states require LLCs and other business entities to meet at least annually. These same states often require an annual filing with the secretary of states’ office. Your trusted LLC attorney can advise what your state requires. Your LLC attorney should also go over the operating agreement with you. If the operating agreement calls for a quorum of at least five board members present, don’t conduct business when there are only three. By failing to follow the operating agreement, your business could be set up for trouble down the road.
Bonus: Jason Hennessey, LosAngelesDUIAttorney.com
One for the first things you need to identify is what state you are going to organize your LLC in. This is a major decision, as that state’s rules and requirements will dictate how your LLC is formed.
Delaware is a very popular choice because of its laws that are favorable for an LLC structure. But, this doesn’t make it the right choice for everyone. In most cases, the state in which you will be operating your business will be the best choice, but again, it’s a case-by-vase basis, and one that should always be discussed with your accountant and attorney.
Make sure you also explore the requirements for doing business in other states, if you will be operating in additional areas, as they often require filing fees. In short, make sure you seek professional help related to setting up your LLC. Doing it correctly the first time will save potential headaches down the road.