An LLC, short for limited liability company, is one of the many ways you can structure your business. You can form a single-member LLC where you are the sole owner, or you can partner with others to start a multiple-member LLC.
Here’s what you need to know about LLCs and their advantages and disadvantages.
What are the pros and cons of forming an LLC?
On the positive side, an LLC helps you avoid double taxation. In other words, you’re not taxed at the company level and then again at the personal level. Instead, the income your business generates passes through to you as the owner and gets taxed as personal income. This is known as pass-through taxation.
And as the LLC name implies, there’s limited liability for you as the owner of an LLC. Your personal assets are protected from lawsuits and creditors.
There are, of course, also drawbacks to having an LLC.
Since the IRS considers LLC members as self-employed, you’ll be on the hook for self-employment taxes. The exception is if you’re in a multiple-member LLC and you’re not actively involved in the management of the business. The regulations surrounding this scenario are complex though, so make sure to consult your accountant.
Taxation can also be complicated depending on how you choose to have your LLC taxed. By default, the IRS taxes single-member LLCs as sole proprietorships. If it’s a multiple-member LLC, you’ll be taxed as a partnership.
But you can also choose to have your LLC taxed as an S corporation or C corporation. The exact details can be complicated, however, so it’s best to work with a tax accountant to decide how you should elect to be taxed.
Lastly, you should also know that LLCs are permitted and governed by individual state laws, which means that forming an LLC may be more advantageous in certain states.
How to start an LLC in 3 steps
If you’re still not 100% sure whether an LLC is right for you, consider working with a business attorney or a tax professional to get a recommendation based on your specific situation.
But if you’re interested in structuring your business as an LLC, the next step is forming it.
Remember that every state has its own rules for starting an LLC, so forming an LLC in California may be different than registering one in Florida.
There are, however, some general steps that typically apply.
1. Get your documents together
There are generally two documents you need to file to set up your LLC: your Articles of Organization and your Operating Agreement.
Articles of Organization. Think of this document as your company basics. It includes your business name and address, the name(s) of its member(s), and who you’ve authorized as a registered agent to handle legal documents on your behalf.
All states require an Articles of Organization to form an LLC. Some states, however, call it a “Certification of Formation” or “Certification of Organization.”
Operating Agreement. This document defines your LLC’s financial and operating processes, rules and regulations, and each member’s powers and responsibilities.
If you’re a single-member LLC with just one owner, you may be able to use an online template to create your Articles of Organization and Operating Agreement.
If your business is more complicated, however, or you don’t feel comfortable doing it on your own, a small business attorney can help you draft the documents.
2. Register your business
If you haven’t already done so, name your business and register it with your state. Contact your Secretary of State’s office or your state’s business bureau to learn more about what’s required to register and how to complete the process.
And since Uncle Sam will require you to pay taxes, you’ll also need to apply for federal and state tax IDs.
The exception is if you’re a single-member LLC with no employees. In that case, you can either apply for an employer identification number (EIN) or just use your Social Security number for your federal tax filings.
3. Apply for licenses and permits
Depending on where you live, you may need to apply for a business license or permit to do business in your city or county. Check with your county and city government websites to find out how and what’s required to apply.
And remember, you can do all of these steps on your own if you want. You can pay an attorney to do it for you, but you don’t need to.