How to Form an LLC

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(Quick Note: Before forming an LLC, we highly recommend brushing up on the basics of what it means to have one. Click here for our savvy breakdown of advantages, disadvantages and more.)

WHAT IS AN LLC & WHAT DOES IT DO?

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. Enjoy!

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

Okay, when you form an LLC you’re creating a real and 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 that’ve already put into the company.

However, it’s “limited” liability, not a free ticket. There are restrictions:

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 Keep Your 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.

  1. 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.
  2. 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.
  3. Distinction: The LLC’s financials should in NO WAY mix with personal income of founders or members – get an EIN, setup an official bank account, and keep the data separate.
  4. Management: While not mandatory, it’s HIGHLY recommended that you have an “Operating Agreement” in place, which is a formally written and signed contractual agreement on finances, management, responsibilities, shares, 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 the 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 strongpoint 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).

To Be, Or Not to Be a Corporation

In some circumstances, pass-through is preferable because individuals will be taxed less than a corporation which is double-taxed – 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).

Common LLC Tax Forms

What are the Biggest Advantages of Forming an LLC?

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 benefits of LLCs,

Again, the importance of an operating agreement cannot 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.

How about the Disadvantages or 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,

Oh, and another thing, US 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 Most Benefits 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 then it could be worth a shot until your platform grows to the point a corporate or some other legal business entity makes sense.

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 am 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 will take to fill out/file forms, pay applicable fees, get an EIN, setup a bank account, and get everything processed.

Have Any Helpful Resources?

Absolutely, Startup Savant has a TON to offer just about anyone interested in starting their own business venture and learning how to form an LLC.

This article on How to Form an LLC 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.