6 Steps To Setting Up An LLC
The laws for setting up an LLC can vary from state to state but the steps are very similar. The best place to start your LLC is on our simple step-by-step LLC guides.
Just select your state from the drop-down list above to get started for free today.
Step 2) Name Your LLC
First things first— you need the right business name in order to register your LLC with the state. Naming your new business goes well beyond creative branding. You could have the most catchy name in Connecticut but if it isn’t unique and legal, you can’t use it.
In order to form an LLC successfully, you have to be sure no one else in your state is using your name and that it meets state guidelines.
To learn exactly how to complete this step for your LLC, select your state from the drop-down list above.
If you need help coming up with a catchy name, try our business name generator. You can use this tool to generate both business names and domain names.
This is a good time to make sure your domain name is available. You can search GoDaddy for free.
Step 3) Choose A Registered Agent
When you fill out your LLC registration forms, you will also need to list your registered agent in most states. A registered agent is sometimes called a resident agent, statutory agent, or agent for service of process.
A registered agent will be responsible for receiving important legal documents on behalf of your LLC. A registered agent’s most important job is to accept service of process (legal summons) in the event of a lawsuit.
Many entrepreneurs choose to hire a registered agent service to help with this part of their business. You can also appoint a friend, colleague, or yourself. In most states, your registered agent must meet these requirements:
- is 18 years or older
- has a physical address in the state where business is conducted
- is available (in person) during normal business hours
To learn more, read our What is a Registered Agent article on Howtostartanllc.com.
Step 4) File Your LLC With the State
This is the step we’ve all been waiting for— it’s time to officially form a limited liability company. You can do this on your own, with the help of a lawyer, or through a professional LLC filing service.
Most states offer online filing and fees for registering your LLC will vary from state to state.
To learn exactly how to complete this step for your LLC, select your state from the drop-down list above.
Step 5) Create an LLC Operating Agreement
Creating an LLC operating agreement is the only way for you and your members to legally define your roles and lock down your LLC’s management and ownership structure. Having this document in place will also give you something to return to if there’s a dispute.
An operating agreement isn’t filed with the state— it’s stored in your company records. The operating agreement should outline:
- each member’s responsibilities.
- how new members will be admitted.
- how existing members may transfer or terminate their membership.
- how profits and dividends are to be distributed.
To learn more, read our What is an Operating Agreement on Howtostartanllc.com.
Step 6) Get an EIN
The Employer Identification Number (EIN), or Federal Tax Identification Number, is basically a social security number for your company. Your EIN allows the IRS to keep track of your business’s tax reporting.
To learn more, read our What is an EIN article on Howtostartanllc.com.
So you’re interested in learning how to form an LLC, brilliant! They’re the most common form of business entity in America for two very good reasons, both of which we’ll dive into below along with the many other advantages and disadvantages.
First, an LLC isn’t a corporation because you aren’t required to maintain a board of directors, elect officers, or take part in any of the other corporate formalities. However, an LLC does have one corporate characteristic, which is where we’ll begin.
Limited Liability: A Brief Explanation
When you form an LLC you’re creating a separate business entity under the law in most jurisdictions. So, now it’s “the company” that can get sued and fall into debt not founders, members, or investors whose personal assets become somewhat protected – they’re no longer liable beyond the money they’ve already put into the company.
However, it’s “limited” liability, not a free ticket. There are restrictions:
- If founders or employees personally and directly injure another person.
- Trying to guarantee lines of credit or business debt with the intention of defaulting.
- Failing to deposit tax money that’s been withheld from employee wages.
- Intentionally taking fraudulent, illegal, or reckless actions that causes harm to the LLC.
- Failing to adequately treat the LLC as a separate and legal business entity.
Before we get into the other major aspect of LLCs, which is how they’re taxed, let’s talk a little about that last point because you’d be shocked to find out how many LLCs lose their limited liability status from the IRS and in court because a judge felt the LLC really didn’t exist.
How to Maintain LLC Status
If you and your members follow the four basic guidelines below, your LLC has a very high chance of keeping its limited liability status over the long haul and in court should an issue arise.
- Transparency: Be fair, ethical, and responsible, and don’t conceal or misrepresent the state of your LLC to the state, federal government, creditors and vendors.
- Funding: There should be enough inbound cashflow/capital to keep the LLC afloat rather than just racking up huge amounts of debt to cover expenses.
- Distinction: The LLC’s financials should in NO WAY mix with personal income of founders or members – get an EIN, set up an official bank account, and keep the data separate.
- Management: While not mandatory, it’s HIGHLY recommended you have an “Operating Agreement”, which is a formally written and signed contractual agreement on finances, management, responsibilities, etc. Without one your LLC is subject to default state/federal rules which may not be as beneficial. And, with no Operating Agreement you’re failing to leverage the flexibility LLCs were created for!
Pretty straightforward guidelines across the board. That being said, let’s move on now to the second big strong point of LLCs which is what’s called pass-through taxation.
Pass-Through Income Taxation
Pass-Through Taxation means the LLC itself isn’t taxed by the Federal Government as a separate entity (some states do though!), instead, taxation and profits/losses pass through the LLC to the members who report these financials on their individual income tax returns.
While you can have an unlimited number of members and there are no citizenship restrictions, the IRS will treat your company as though it’s a sole proprietorship (single-owner LLC) or partnership (multi-owner LLC).
- Single-Owner: The LLC itself pays no taxes and doesn’t have to file, only the owner/founder.
- Multi-Owner: Each member/owner pays taxes in accordance to their “distributed share” of the profits/losses as stated on their personal income tax returns. Shares should be stated clearly in the LLC operating agreement (contract).
To Be, Or Not to Become a Corporation
In some circumstances, pass-through is preferable because individuals will be taxed less than a corporation which is double-taxed. Or, in other words, once on the corporate level and then again when profits are distributed to shareholders.
However, there are also plenty of circumstances where an LLC will switch to a corporation to leverage the other benefits (stock options, tax incentives, etc.), and the corporate income tax rates may be better than individual. This is where consulting with a tax attorney or qualified accountant comes in handy.
To summarize the taxation aspect, by default the IRS will treat an LLC as either a sole proprietorship or partnership. Beyond this the LLC can opt to become either a conventional corporation (c-corp) or get a special designation (s-corp).
- C-corporation: separate taxable entity that pays corporate taxes, possibly double.
- S-corporation: gets pass-through taxation, no corporate taxes.
Common LLC Tax Forms
- Partnership income/loss report IRS Form 1065.
- IRS Form K-1 reports members distributive share of income/loss.
- IRS Form 8832 “Entity Classification Election” if the LLC wants to be taxed as a corporation.
- C-corporation: tax return IRS Form 1120.
- S-corporation: Must file IRS For 2553 to become an S-corporation, then submit informational tax return IRS Form 1120S.
The Biggest LLC Advantages
The biggest advantage for most entrepreneurs, small teams, and startups who form an LLC is flexibility in terms of taxation and management. Then there’s the personal/asset protection of limited liability. Here’s a handful of the other popular LLC advantages,
- LLCs are allowed to deduct all normal business expenses which include paid salaries BEFORE they distribute any income to members which can help lessen overall tax burdens.
- You can form an LLC anywhere in the U.S., from sea to shining sea, and the registration process can be simpler than with corporate/non-profit entities.
- Startup costs and fees tend to be lower, at least when it comes to the paperwork side of things at the initial founding and over time.
- Members are free to dispense or distribute profits as they see fit, within the bounds of overarching state and federal laws of course.
- Unlike most Corporations, members can distribute profits and ownership interests in creative ways that don't necessarily correspond to capital contributions. For instance, one member might contribute $10,000 cash along with a great business plan and business relationships, and another member might just contribute $90,000 with no intangible contribution, but the the members could agree in the operating agreement that each member is entitled to 50% of the profits and a corresponding 50% membership interest.
Again, the importance of an Operating Agreement can't be over-stated for LLCs with more than one member! They’re what make it possible, in the eyes of the law or in court if you end up in one, to use an LLC for its intended purpose.
Disadvantages & Challenges
Listen, if you aren’t trained in business taxation, or at least LLC-specific taxation, and you don’t have an attorney or qualified accountant…PLEASE think this through! One of the disadvantages is that the tax situation can get confusing fast depending on how complex your company operations/management are.
Here are some other considerations:
- Funding: LLCs can find it more difficult to raise funding because many investors are after corporations or LLCs with lots of funding headed towards an Initial Public Offering (IPO).
- Franchise Tax: Along with typically higher renewal fees, many states levy a franchise tax on LLCs as a sort of fee to pay for the benefits of limited liability. This fee can be based on revenue, profits, the amount of capital employed in the state, a combination, or just be a flat fee like they charge in Delaware.
- Dissolution: In most states your LLC can completely fall apart or dissolve and lose its status if one member decides to quit, thus leaving any financial debts/obligations to remaining members. Only an operating agreement provision can prevent this.
- Non-Corporate: No board of directors or officers means that managing an LLC can be vague (especially with no operating agreement) and this can be challenging.
- Federal Taxes: There are instances where an S-Corporation is a more appropriate pass-through vehicle for tax purposes, especially when the goal is to save on self-employment taxes.
Oh, and another thing, U.S. Limited Liability Companies aren’t recognized by most taxing countries so this could cause some issues if you don’t have a great attorney in place!
Who Benefits Most from Forming an LLC?
To be honest, if your business works directly with the public or is regularly involved in situations where other people and their property could be damaged you should consider limited liability protection. Then, of course if the numbers make sense it could be worth a shot until your platform grows to the point a corporation or some other legal business entity makes sense.
- Can’t typically be involved with a banking trust, insurance, and some professional titles like accountants, doctors, licensed healthcare workers, architects, etc.
- Self-employed folks should also consider the coverage along with the ability to be taxed differently – it’s easier! You turn your product/service into a brand and then become an employee who collects a paycheck.
Beyond these basics, many brands also want to benefit from the additional credibility and distinction that comes along with forming an LLC. So, instead of “Tommie’s Beads” it becomes something more official like “Tommie’s Beads LLC.”
Is There an Ideal Time to Form an LLC?
If you’re asking whether there’s an official income threshold where an LLC should be considered, no. It really just comes down to when you as a sole proprietor or together with your founding members feel that it a) makes sense financially, and b) your platform warrants limited liability protection.
Also, let’s say income shoots up and you want to form the LLC before tax time hits, or the end of the year, do consider the length of time it takes to fill out/file forms, pay applicable fees, get an EIN, set up a bank account and get everything processed.
When is the Right Time to Form an LLC?
Advantages and Disadvantages of Forming an LLC
What is the Difference Between a DBA and an LLC?
What Is An LLC Corporate Veil?
What Is a Foreign LLC?
What Is a Series LLC?
Form an LLC in..
Below are useful references for understanding and getting started:
- Howtostartanllc.com: "What is an LLC?"
- IRS.GOV: "How the IRS Classifies an LLC"
- New York Department of State: "Limited Liability Companies FAQs"
This article on Startup Savant is not a legal document or legal advice. It is for informational purposes only and the information is subject to change over time. For specific questions and concerns regarding how to form an LLC, please consult an accredited attorney or a qualified professional.