Starting a Limited Liability Company
A limited liability company is valuable for the protections and simplicity it offers its owners. It is a flexible form of ownership that can also be useful for tax planning.
A limited liability company (LLC) is a hybrid entity that combines the tax flow-through aspects of a partnership with the liability protection of a corporation or a limited partnership. However, unlike limited partners in a limited partnership, who lose their limited liability status if they attempt to manage the business, a member of an LLC is not prohibited from managing the business.
The LLC entity form is available in all 50 states and the District of Columbia. However, the laws among the various states differ somewhat in their treatment of an LLC. As a result, transactions outside the state of formation by the LLC may be treated differently from transactions within the state of formation.
For federal tax purposes, an LLC is treated and taxed, by default, as a sole proprietorship if there is only one member. It is treated and taxed, by default, as a partnership if there is more than one member. Businesses can elect to be treated as a corporation by filing Form 8832, Entity Classification Election. Older LLCs will be presumed to continue the federal tax status they had on January 1, 1997.
Forming an LLC
To form an LLC, articles of organization must be filed with the secretary of state's office. The articles of organization contain information about the LLC, such as its name, address, purpose, who organized it, who the registered agent is, etc. The operating agreement is similar to a partnership agreement. Its purpose is to guide the conduct of the business. If the operating agreement is not required to be filed with the articles of organization, it can generally be in written or oral form. As a precautionary measure, the operating agreement should be written to limit future conflicts.
In addition, you must consider whether the company will conduct business across state lines. If so, you may consider forming the LLC out-of-state. You also have the option of qualifying the LLC as a foreign entity with state authorities, registering it to do business within that state's borders. The foreign qualification process requires the filing of some forms and paying some initial and annual state fees and taxes.
Advantages of a limited liability company.
- Limited liability: Members are shielded from being personally liable for acts of the LLC and its members.
- Flexible membership: Members can be individuals, partnerships, trusts, or corporations, and there is no limit on the number of members.
- Management: Members can manage the LLC or elect a management group to do so.
- Flow-through treatment: Income, losses, deductions, and tax credits flow through the LLC to the individual members.
Although the limited liability company form generally results in limited liability for its members, lenders usually require some or all members of a limited liability company to personally guarantee business loans.
Disadvantages of a limited liability company. There are very few disadvantages to using an LLC and the advantages can easily outweigh the disadvantages.
- Free transferability of interest: In older LLCs, transferability of interest was usually restricted to enable the LLC to be treated as a partnership.
- Cost: An LLC usually costs more to form and maintain than a sole proprietorship or a general partnership. States may also charge an initial formation fee and an annual fee; check with your secretary of state's office.
Limited liability company tax issues. A multiple-member LLC is treated as a partnership for federal tax purposes, unless an election is made to be taxed as a corporation. Because the individual members are treated as partners, they may be subject to self-employment taxes.
If the business hires employees, a Federal Employer Identification Number will need to be obtained and payroll taxes will have to be paid. The Federal Employer Identification Number can be obtained by filing a Form SS-4, Application for Employer Identification Number.
Forming a Limited Liability Partnership
Limited liability partnerships are similar to limited liability companies in terms of the tax advantages, but they differ in that limited liability partnerships are normally available only to select professions, such as doctors or lawyers. For more information on LLPs, see limited liability partnerships.