How to Form an LLC

Understanding how to create a Limited Liability Company (LLC)

Limited liability companies (LLCs) are a popular choice among small business owners for the liability protection, management flexibility, and tax advantages this form of business entity often provides.

Creating or forming an LLC means that owners are typically not personally responsible for business debts and liabilities. Like partnerships, LLCs also provide pass-through taxation. This means that LLC income is reported on the owner’s personal tax returns and any tax is paid at the individual level.

Steps to Forming an LLC

Although generally easier to form than a corporation, there are some administrative and compliance tasks to be done. To help you form an LLC successfully and in compliance with state law, follow these eight steps.

Steps to form an LLC

Step 1: Choose a State in Which to Form Your LLC

Although you can choose to form an LLC in any state—even if the LLC won’t be doing any business there —most small business owners choose to form an LLC in the state in which they plan to do business—which in many cases is the state they live in. One reason for that is that if the LLC is formed in a state where it is not doing business—Delaware is the usual choice for these LLCs—the LLC will have to register (aka foreign qualify) to do business in the state where it is doing business, which can increase the formation and administrative costs.

It’s important to note that the cost, taxation, and LLC laws vary from state to state, making some states more advantageous for certain small business owners. Read more about how to select a state for LLC formation.

Step 2: Choose a Name for Your LLC

In order to form an LLC, you’ll have to choose a name that is not already on the Secretary of State’s records as being the name of another domestic or qualified LLC or other business entity. Many sole proprietors operate under a registered “doing business as” (DBA) name or trade name and may want to use that as their LLC’s legal name. To ensure the availability of the name you want for your LLC, whether it’s registered as your DBA name or not, you should conduct an LLC name search on your formation state’s website to determine whether your desired name is available. If you’re not ready to file your LLC formation document quite yet, it is a very good idea to reserve the name. Many states allow you to do that for a small fee and short time period.

It’s also a good idea to conduct a trademark search of the name you want to avoid intellectual property infringement or confusing your customers.

Step 3: Choose a Registered Agent

In forming an LLC or registering an existing LLC to transact business in a foreign state, you are required to have a registered agent in the state of formation or qualification. Many new business owners are either unfamiliar with the term registered agent or do not know the purpose of a registered agent.

A registered agent, also known as an agent for service of process, receives important legal and tax documents on behalf of an LLC. These include important documents, notices, and communications mailed by the Secretary of State (such as annual reports or statements) and tax documents sent by the state’s department of taxation. A registered agent also must be available to receive service of process—(sometimes called Notice of Litigation) which are documents—typically a summons and complaint, that provide notice that a lawsuit has been filed against the LLC. Other court documents such as garnishment orders and subpoenas are also served on the registered agent.

While the owner of an LLC can choose to serve as the LLC’s registered agent, there are a number of compelling reasons why business owners—even the smallest ones—choose a registered agent service provider to assist with this important requirement. Among other things, if the registered agent is not available when these time-sensitive documents are delivered, or if the person receiving them mishandles them, it can cause the LLC serious problems.

Step 4: Prepare an LLC Operating Agreement

An LLC operating agreement is required in nearly every state. And although in most states it can be oral, it is highly recommended that every LLC have a written operating agreement. As the name implies it is an agreement among the members and between the LLC and the member or members as to how the LLC will be operated. Even if you are the only member it is important to have an operating agreement. It shows you respect the LLC’s separate existence (and can help avoid piercing the veil), it gives you a chance to put in writing what you want to happen in certain circumstances such as if you can no longer manage the business, and allows you to opt out of certain default provisions of the LLC statute that you might not want the LLC to be governed by.

It is particularly important for multi-member LLCs to have a well-drafted operating agreement. This document will clearly spell out the division of ownership, labor and profits, and often heads off disputes among the owners. It should detail, among things, who has authority to do what, what vote is required to approve certain transactions, how membership interests can be transferred, how new members can be added, how distributions, profits and losses will be split, and more. It is recommended that the operating agreement be reviewed by your attorney to be sure that all the bases are covered. Read more about the issues an operating agreement can address.

Step 5: File Your LLC with Your State

To make your new LLC officially exist you must file LLC formation documents (also known as a Certificate of Organization, Certificate of Formation, or Articles of Organization) with the Secretary of State’s office or whichever department handles business filings in the state in which you are forming. Filing fees vary across the U.S.

Did You Know? 

What about LLC Articles of Organization?

Although it may be common to hear of an LLC being “incorporated”, the correct way to describe the creation of an LLC (or any entity type other than a corporation) is to say that it has been “formed” or “organized”. “Incorporation” and “Articles of Incorporation” are terms that apply to a corporation (regardless of whether it is taxed as a C corporation or S corporation).

While each state’s LLC formation document is different to some extent, there are several common elements. These include the following:

  • Name, principal location and purpose of the business
  • Registered agent’s name and address
  • Whether the LLC will be member-managed or manager-managed

Standard forms for the articles of organization for an LLC are generally available from each state. The person who formed the LLC must sign the paperwork. In most cases that does not have to be a member or manager. In some states, the registered agent’s consent to act as registered agent is also required.

Once approved and filed, the state will issue a certificate or other confirmation document. The certificate serves as legal proof of the LLC’s status and can be used to open a business bank account, obtain an EIN, and so on. Some states may also require that you publish a notice, often in a local newspaper, confirming the formation of the LLC.

Step 6: Obtain an EIN

After establishing the business entity, you must apply to the Internal Revenue Service for an employer identification number (EIN). This is the identification number your LLC will use on all its bank accounts, as well as income and employment tax filings. In addition, in each state in which the LLC will be doing business, you must apply to the state's tax department for a sales tax identification number and register with the state's labor department.

Step 7: Open a Business Bank Account

This step is not a legal requirement but is a key best practice for anyone who is creating an LLC and is one of the steps outlined in our guide: 10 Steps to Starting a Business. It is crucial to separate business finances from personal ones. This is one of the main factors courts consider when deciding whether to pierce an LLC’s veil and hold the member liable for the LLC’s debts. Most banks require company details, such as formation date, business type, and owner names and addresses. Contact your bank about requirements prior to opening an account.

Step 8: Register to Do Business in Other States (If Necessary)

If the LLC you formed is going to be doing business in more than just the formation state you will have to register—or foreign qualify—in each “foreign” state. That generally requires filing an application for authority with the Secretary of State. A Certificate of Good Standing is often required as well. The LLC will also have to appoint and maintain a registered agent.

Many factors are used to determine whether a company is transacting business in a state, and therefore needs to foreign qualify. Some of the common criteria include whether your company -

  • has a physical presence in the state
  • has employees in the state
  • accepts orders in the state

Note that different states have different criteria. To determine whether your LLC needs to foreign qualify in a certain state, it is best to seek the advice of an attorney.

Advantages and Disadvantages of Creating an LLC

Whether you are starting a business, or have been operating as a sole proprietorship or general partnership, you may be wondering about the benefits of operating your business as an LLC. Some business owners fear it will be too costly or time-consuming—but in general, neither is the case.

Benefits of Forming an LLC

The benefits of creating an LLC—as opposed to operating as a sole proprietorship or general partnership, or forming a corporation—typically outweigh any perceived disadvantages.

  • Limited liability: Members (which is what the owners of an LLC are called) are shielded from being personally liable for acts of the LLC and its other members. Creditors cannot pursue the personal assets (house, savings accounts, etc.) of the owners to pay business debts. Sole proprietors and general partners, on the other hand, are liable for the business’ debts.

    Note: It is possible for an LLC (as well as a corporation) to lose its limited liability. This is known as “piercing the veil”. For more information, see How to Avoid Piercing the Corporate Veil.

  • Flexible membership: Members can be individuals, partnerships, trusts, or corporations, and there is no limit on the number of members. S corporations (which is a corporation that has elected to be taxed as a pass-through entity under Subchapter S of the Internal Revenue Code) are much more restricted in who can be a shareholder, and there is a maximum limit on the number.

  • Management: Members can manage the LLC or elect a management group to do so. Corporations, on the other hand, are managed by a board of directors, not shareholders.

  • Pass-through taxation: LLCs typically do not pay taxes at the business entity level. Any business income or loss is "passed-through" to owners and reported on their personal income tax returns. Any tax due is paid at the individual level. Corporations that cannot, or choose not to be taxed as an S corporation (these are known as C corporations because they are taxed under Subchapter C of the IRC) are taxed at the business entity level and their shareholders are taxed on the income distributed to them.

  • Heightened credibility: Forming an LLC may help a new business establish credibility more so than if the business is operated as a sole proprietorship or partnership.

  • Limited compliance requirements: LLCs face fewer state-imposed compliance requirements and ongoing formalities than sole proprietorships, general partnerships, or corporations (whether taxes as S corporations or C Corporations).

Disadvantages of Creating an LLC

There are a few disadvantages to creating an LLC too, although in many cases the advantages can outweigh the drawbacks.

  • Cost: An LLC usually costs more to form and maintain than a sole proprietorship or a general partnership. States charge an initial formation fee. Many states also impose ongoing fees, such as annual report and/or franchise tax fees. Check with your Secretary of State's office.
  • Transferable ownership. Ownership in an LLC is often harder to transfer than with a corporation. With corporations, shares of stock can be sold by the corporation to increase ownership and unless there is a shareholder agreement to the contrary, the shareholders can sell their shares to someone else. Typically, with LLCs, unless the members agree otherwise, all members must approve adding new members or altering the ownership percentages of existing members.

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