Choosing the right business structure is potentially critical to the success of your enterprise. The decision is particularly important if you intend to seek outside financing. If you are looking for loans or government-based business grants for women or minorities, the structure of your operation may be key.
Limited liability companies (LLC) combines various aspects of a corporation and a partnership. Like a corporation, an LLC has limited liability features, while it abides by tax rules and operates similar to a partnership. Instead of owners, an LLC has members, and the members may be one or more individuals, a corporation or an LLC. The members of an LLC account for all profits and losses on their individual taxes, like owners of a partnership.
How An LLC Is Formed
There are general procedures to form an LLC, although there will be slight variations based on state and jurisdiction:
You must choose a name for your LLC. The name must be unique from any other LLC in your state, the name must indicate that it is an LLC by adding ‘LLC’ or ‘Limited Liability Company’ to the name, and the name of your business must not include any restricted words. Restricted words can vary by state, but typically include words such as ‘bank’ or ‘insurance.’ When you register your business with your state the name is automatically registered and does not require a separate registration process.
Next, you must submit the articles of organization. The articles of organization is a document that includes the name, address and information about the members of your LLC. It is required to legitimize your LLC. Where you submit your document depends on your state. In most instances you will file the document with the Secretary of State, but the Department of Consumer and Regulatory Affairs, State Corporation Commission or Division of Corporations and Commercial Codes are among other agencies where you may need to file your document, and you may need to pay a filing fee.
Next, you must draft your operating agreement. An operating agreement is not always required by the state where your LLC is located. Even when an operating agreement is not required, it is good business practice for LLCs with multiple members. The operating agreement outlines your LLCs operations, organization and finances. Included in the operating agreement are the allocation of profits and losses, the rights and responsibilities of members in the LLC and other pertinent information.
Obtain any required licenses and/or permits. After you register your business, you will need to obtain any business licenses or permits. The necessary licenses and permits will vary by locality, state and the type of industry for your LLC. You can use the licensing and permits tools to find an applicable list of local, state and federal permits, licenses and registrations that are required to run your business.
You may want to hire employees. If you decide to hire employees now or in the future, you will need to read about regulations at the state and federal level for employers.
Announce the formation of your LLC. The process of announcing your LLC also varies by state, some states, such as New York, require that you publish information about your LLC in the local newspaper. Your state’s business filing office will provide you with the requirements for your area.
State And Federal LLC Taxes
In general, the LLC is not recognized as a business when considering federal income taxes; therefor the business is not taxed. Federal income taxes and liabilities are paid by the members when they file their personal income taxes. Although there is no federal income tax for LLCs, some states continue to require state taxes. Therefore, you must check with you state’s tax agency to make sure you a filing taxes appropriately.
LLCs must file their tax returns using the tax forms for corporations, partnerships or sole proprietorships. Although the federal government does not recognize an LLC as a business for taxation purposes, some LLCs are automatically classified and taxed as a corporation. Visit IRS.gov for information on classifying as an LLC.
When a business does not automatically classify as a corporation, they can choose their classification. The LLC must submit Form 8832 to select a classification. The same form is used if an LLC needs to change their classification. Read more about filing as a single member LLC, corporation or partnership at IRS.gov.
Combining The Benefits Of An S-Corporation With An LLC
You can request S-Corporation status for your LLC. Speaking with an attorney can help you determine the advantages and disadvantages of requesting S-Corporation status. You will have to submit Form 2553 to the IRS, which can be accessed online if you have Adobe Reader. The form allows you to make a special election with the IRS to have your LLC taxed as an S-Corporation.
You must submit the form before two months and 15 days into the tax years in which you want the election take effect. You can visit IRS.gov or read ‘Should My Company Be An LLC, an S-Corp or Both?’ for more information.
You should contact your state’s income tax agency where you file the form. Every state is different in their tax requirements and if they recognize other business entities. When you combine the benefits of an S-Corporation with an LLC, your business keeps the limited liability of an LLC, but is only recognized as an S-Corporation for tax purposes.
Pros of Forming An LLC
Having limited liability means the members do not have personal liability for anything that occurs during the scope of the business. Personal assets are typically exempt from debt and lawsuits against the LLC, which is similar to the liability protections of shareholders in a corporation. As its name implies, the liability is limited and members are not immune to liability from wrongful acts committed by the business or its employees.
Easier recordkeeping. A major advantage of an LLC over an S-Corporation is the smaller startup costs, with less registration paperwork. Furthermore, the ease of operating an LLC is another advantage.
Profit-sharing for an LLC has fewer restrictions, because members can dispute profits when necessary. Since members of the LLC often contribute different proportions of capital and equity, it is up to the members to agree on the percentage of profits and losses that are the responsibility of each member.
Cons of Forming An LLC
LLCs often have a limited life. Many states require that remaining members of an LLC must fulfill any remaining business and legal obligations to close and dissolve the business, once a member leaves. Any remaining members of the LLC can decide to part ways or start a new LLC. This reiterates the importance of having an operating agreement, even when it is not required by your state. The operating agreement can prolong the longevity of the LLC if a member leaves the business.
Members must pay self-employment taxes. The members of the LLC are considered self-employed when filing for taxes and must pay the usual contributions to Social Security and Medicare. The net income from the LLC is used to determine the tax rate.
If you’re about to start your own business, you have many different organizational options available to you. The sole proprietorship is the simplest and most straightforward one. This creates a business that is owned and operated by you, the solitary owner of the company. While you are free to take all the profits generated by a sole proprietorship, you’re also financially responsible for its liabilities, debts, and losses.
How To Create A Sole Proprietorship
Unlike most other organizational strategies, a sole proprietorship doesn’t require any legal or regulatory actions to create. As long as you’re running a business using only assets that you own, you qualify as a sole proprietor. This means that many freelancers technically qualify as sole proprietors.
Although you don’t have to file any special paperwork to create your business, you do still have a responsibility to obtain all of the permits and licenses required to operate in your field. The specific industry you work in and the local regulations of your state and city all determine what credentials will be required. You can make use of the Licensing & Permits tool to check your needs and ensure that you’re complying fully with the rules that apply to you.
If you want your business to have a separate name, this usually has to be formalized by submitting it to the relevant authorities. It’s often referred to as a fictitious name, a trade name, or a “doing business as” or DBA name. Your trade name must be unique to you alone; no two businesses can use the same name.
Tax Implications Of Sole Proprietorship
The good news is that your tax situation as a sole proprietor is relatively straightforward. The profits of your business translate directly into the personal profits you list on your Form 1040. Schedule C is the proper worksheet for sole proprietors to properly calculate income, expenses, and losses. Bear in mind that you assume full responsibility for withholding and paying all the applicable income taxes, which includes self-employment tax. Research your tax situation carefully by checking the reference materials available at IRS.gov.
Benefits Of Being A Sole Proprietor
- Simple Formation: No other business structure can beat sole proprietorship when it comes to speed, simplicity, and affordability of formation. The costs involved are trivial, and the only regulatory obligation is obtaining any necessary licenses.
- Full Control: Being a sole proprietor entitles you to make every decision about your business yourself. No consultations are required, and you can change how you do business at will.
- Simple Tax Situation: Since your business is not a separate entity, you don’t have to record, report, or pay any additional taxes. Adjusting your personal return to reflect your business is easy, and your overall tax burden is lower than it would be with other business structures.
Drawbacks Of Being A Sole Proprietor
- Full Personal Liability: You have no shield protecting your personal finances from the financial state of your business. Your own assets may be at risk in severely adverse conditions. From a legal standpoint, you’re personally responsible for any and all actions taken by you and your employees.
- Funding Difficulties: It’s not easy to raise capital when you’re a sole proprietor. Banks are leery about lending to sole proprietors due to the liability issues discussed above, and investors may not be interested in a business without stock.
- Great Responsibility: The downside to exercising complete control of your business is that you can’t avoid doing so. Your business’s success or failure is entirely up to you.