Limited Liability Companies
Selecting an LLC for a new business venture requires an analysis of the pros and cons of the entity relative to your specific circumstance and needs, therefore, we have assembled a brief Q&A regarding the essentials related to the choice of a LLC.
- What is an LLC?
- What are the advantages of an LLC?
- How does an LLC help protect my personal assets?
- How are LLC profits taxed?
- How does an LLC compare to a C Corporation?
- How does an LLC compare to a S Corporation?
- What is a Series LLC?
- What state should I form my LLC in?
- How do I form an LLC?
- What do I need to do to maintain my LLC?
A limited liability company (“LLC”), is a business entity created under state law that combines the limited liability characteristics of a corporation with the tax-free characteristics of a partnership. The owners of an LLC (called “Members”) are generally not liable for claims against the LLC. If the LLC has two or more members, the member should execute a limited liability company operating agreement (“Operating Agreement”), which is drafted by an experienced lawyer. Mr. Raines is experienced in the operation of limited liability companies and negotiating and drafting of Operating Agreements and can protect your interests in entering into membership in a limited liability company.
What Are the Advantages of an LLC?
The benefits of forming an LLC include:
- Owners have limited liability for business debts and obligations, protecting their personal savings and possessions.
- Owners can report their share of profit and loss on their individual tax returns without filing a separate corporate tax return.
- Owners need not be U.S. citizens or permanent residents.
- LLCs need not hold annual meetings or record meeting minutes (though we recommend it).
How Does Forming an LLC Help Protect My Personal Assets?
Unlike sole proprietorships and partnerships, LLCs allow their owners to separate and protect their personal assets from business debts and liabilities. A sole proprietor or general partner remains personally liable for business obligations, leaving their home, car, and personal savings at risk.
In contrast, forming an LLC creates a business structure separate from its owners. In a properly formed and managed LLC, only business assets remain at risk in a judgment against the company. Owners can protect their personal savings and possessions from business debts.
How Are LLC Profits Taxed?
The LLC itself is not a taxable entity. An LLC can be managed by the Members themselves or by an appointed manager or group of managers. A single member LLC is a disregarded entity for federal income tax purposes and does not have to file an income tax return. The business activities instead are reported through Schedule C in the sole Member’s federal income tax return. An LLC that has two or more owners must file a federal partnership tax return, but it does not pay tax itself. Each Member receives a K-1 showing his/her/its prorata share of the income.
How Does an LLC Compare to a C Corporation?
For many small business owners, a Limited Liability Company (LLC) offers advantages over a “C Corporation” (also known as a “general” corporation). Creating an LLC combines the tax advantages of a sole proprietorship or partnership with the liability protection of a corporation.
The IRS taxes the profits of a C Corporation at corporate tax rates. Then, if the C Corporation pays dividends to shareholders, the IRS taxes those dividends a second time at the personal income tax rates of the shareholders. The LLC business structure avoids this “double taxation.” The Internal Revenue Service (IRS) does not consider an LLC itself a taxable entity. Instead, the company’s earnings “pass through” to the owners, who report their share of profits or losses on their individual tax returns.
Small business owners who want the flexible structure of an LLC but the advantages of corporate taxation can elect corporate taxation for their LLC. To elect corporate taxation, owners file Form 8832, “Tax Classification Election,” with the IRS. Electing this status may also make an LLC eligible for certain deductions available only to corporations. For specific guidance, small business owners should consult their accountant or tax advisor regarding this election.
How Does an LLC Compare to an S Corporation?
The Limited Liability Company (LLC) and the Subchapter S Corporation (“S Corporation”) share the benefit of pass-through taxation. This means that owners in the company report their share of profits and losses on each owner’s individual tax return. The Internal Revenue Service (IRS) assesses no separate tax on the company itself. In contrast, “double taxation” occurs when the IRS taxes both a C Corporation’s profit and dividends paid to shareholders.
Despite the similarity of pass-through taxation, an LLC formation can offer advantages over an S Corporation:
- Not required to hold annual meetings or record meeting minutes (though we recommend it)
- LLC owners need not worry about the formalities of issuing stock, since an LLC does not have stock
- No limit to the number of owners
- LLC owners need not be U.S. citizens or permanent residents
A Series LLC consists of a Limited Liability Company with more than one series of members, managers, or LLC interests. In some cases, a series LLC can have a separate business purpose or investment objective. For years, Delaware law has permitted an LLC to register separate series.
Use of this structure remains uncommon due to uncertainty over federal income tax consequences. Advantages include:
- The Series LLC permits separate liability-insulated divisions within a single entity.
- A Series LLC could be used as a holding company owning intangible assets, or tangible assets such as real estate, or as an operating company conducting different lines of business.
- The Series LLC reduces costs associated with forming and maintaining multiple LLCs.
What State Is the Appropriate State to Form My LLC?
Most businesses form LLCs in the state in which they primarily operate. Advantages of choosing your home state include:
- Typically the least complicated option
- Usually costs less than forming your LLC in a different state and registering with your home state
- Avoids paying franchise taxes and filing annual reports in more than one state
Many companies conduct business throughout the U.S. and abroad. An LLC with business locations in multiple states may form an LLC in a single state and then register to do business in the additional states. This means that companies must formally register, file annual reports, and pay annual fees to conduct business in multiple states.
How Do I Form an LLC?
Articles of Organization filed with the Secretary of State of the State chosen.
What Do I Need to Do to Maintain My LLC?
Nearly all states require LLCs to file annual reports or pay franchise taxes to maintain the company’s good standing. The Secretary of State may forward a renewal notice directly to your company or to your Registered Agent. Failure to file reports and pay franchise taxes by the state deadline can result in fines, notices, and the inability to conduct business.
State laws do not require LLCs to hold annual meetings or record meeting minutes. However, we recommend that LLCs update their records at least annually to reflect any changes in management or activities.
Almost all state, county, and local governments require LLCs to complete business license, permit, and tax registration applications before beginning to operate.