Limited liability companies (LLCs) are popular business entity among entrepreneurs because of the many benefits they offer. Of particular allure to business owners is the personal liability protection that an LLC offers. An LLC is a separate entity from its owners, called members, and has its own assets and liabilities, therefore members are not personally liable for the obligations of the company.
An LLC is also a pass-through entity, meaning that the profits and losses of the business are passed through to the members to report on their personal tax returns. The LLC itself is not taxed.
Forming an LLC involves registration with your state. You simply file a document, usually called the articles of organization, with your state’s relevant department. It’s a very simple process; however, there are a number of other important steps that you might not know about or that you might forget.
Here we will explain those critical steps so that you can get your business off on the right foot.
Choose a Registered Agent
Before you form your LLC with the state, you’ll need to choose a registered agent for your LLC. A registered agent is required in nearly all states and is a person or company authorized to accept official correspondence and important documents on behalf of your LLC. Each state has requirements regarding who can be a registered agent, but generally, a registered agent must:
- Be 18 years of age or older
- Have a physical address in the state
- If the agent is a business, it must be authorized to do business in your state
- Be available during standard business hours
You can be your own registered agent, or you can choose another person or a company. Many entrepreneurs choose to hire a registered agent service to save time and to ensure that no important correspondence or documents are missed.
When you form your LLC with the state, the document will require your registered agent’s name and address. By including it on the form, you’ll be officially appointing your registered agent.
Decide on a Management Structure
Some states require that you specify a management structure for your LLC on your formation documents. LLCs can be member-managed or manager managed.
In a member-managed LLC, all members are involved in the day-to-day management of the company. In a manager-managed LLC, managers are generally hired to manage the LLC, sometimes in conjunction with one or more members of the LLC.
It’s important to note that in a member-managed LLC, ALL members are involved in managing the LLC. If one or more members are passive owners and not involved in the management of the LLC, the LLC is considered manager-managed, even if outside managers are not hired. The members who are not passive owners and who will manage the LLC are considered the appointed managers.
Draft an Operating Agreement
This is a step that many entrepreneurs miss, but it’s of critical importance. An operating agreement, while not required in most states, contains many provisions about how the LLC is owned and managed. It specifies member ownership percentages, how profits or losses are distributed, member roles and responsibilities, voting procedures and rights, how disputes are settled, and much more.
Without a written operating agreement, state default regulations will apply, but those laws are not always clear in certain circumstances. This means that member disputes often end up being settled in court.
It’s highly recommended that you have an attorney involved in creating your operating agreement so that all necessary provisions and language are included.
The operating agreement is not filed with the state, but must be kept in your company records
Choose Your LLC’s Tax Status
LLCs are unique in that you can choose how your LLC profits and losses will be taxed. As mentioned above, LLCs, by default, are pass-through entities. If your LLC has only one member, it’s taxed as a sole proprietorship. If your LLC has more than one member, it’s taxed as a partnership. In either case, profits and losses are passed through to members to be reported on their personal tax returns, and the LLC is not taxed.
However, in both of these scenarios, the member or members are responsible for paying self-employment taxes as well as income taxes on profits. As of 2023, the self-employment tax rate is 15.3%, which can add up to a hefty amount.
But, to avoid self-employment taxes, you can have your LLC taxed as either an S-Corporation or a C-Corporation. An S-Corporation is the most common choice because profits and losses are still passed through to members. However, a corporation status means more administrative responsibilities and costs, therefore the self-employment tax savings must be more than those added costs in order to be beneficial.
It’s a bit of a complex decision and best made with the help of your tax advisor.
Apply for an Employer Identification Number (EIN)
If your LLC has more than one member or if you are hiring employees, you’re required to have an EIN. An EIN is like a social security number for your business and is used by the IRS to identify your LLC. It also may be required to open a business bank account.
An EIN is free and easy to apply for. You can do so online on the IRS website.
You may also have to register for a state tax ID number, so check with your state for requirements.
Obtain Business Licenses
Depending on your location and type of business, you may need to apply for various business licenses and permits. Some states require a general business license as well as other licenses, and some licenses and permits may be required at the local level.
The most common permit is a sales tax permit, required if you sell taxable goods or services.
Check with your state and local governments for specific requirements.
Speak With Your Insurance Agent
You’ll want to protect your investment in your LLC, so have a conversation with your insurance agent about various types of business insurance that you may need. At the very least, you should have general liability insurance. Other common types of insurance are professional liability insurance, business property insurance, and worker’s compensation insurance.
Open a Business Bank Account
It’s very important to keep your business and personal finances separate, even if you’re the only member of your LLC. You should do so for tax and accounting reasons, but also to keep your personal liability protection intact. Comingling business and personal finances can blur the line between you and the LLC as separate entities, so it could be argued that you and the business are acting as one and the same.
Check Annual Report Requirements
Most states require that you file an annual report for your business. Generally, the annual report forms are very simple and just verify your business information and that you are still doing business. They usually come with a fee that varies by state. Check with your state for reporting requirements and be sure to file on time. Not filing annual reports can result in penalties and even the dissolution of your LLC.
In Closing
While registering your LLC with your state is simple and takes very little time, you should not forget or skip any of the steps we’ve outlined. Starting a business is a big step in and of itself, and you want to make sure you do everything right. It’s a good idea to have your attorney and tax advisor involved in the process to make sure all your bases are covered and that you make choices that will give you the best chance of success.
Author: Carolyn Young