What is an LLC?
An LLC is a much newer business entity than the corporation. The first LLC was formed in Wyoming in 1977 and they weren’t commonplace until the 1990s. However, LLCs now outpace the corporation as the most popular type of business entity. By default an LLC has three distinct features:
- Limited Liability: Once formed, the LLC can do business in its own name, own property and be taxed. The LLC is given all the rights a person has and with the primary purpose of doing business. The LLC provides a unique legal distinction between the owners (members) and the LLC itself. This separation grants limited liability, which means the LLC’s assets are separate from the owners’ assets. For example, should the LLC be sued, only the LLC’s assets are at stake, not the owners’ assets. This is known as asset protection.
- Flexible Tax Structure: The LLC was designed as a hybrid between corporations and partnerships. It utilizes the asset protection of a corporation, but it is taxed similar to a partnership, which is to say not taxed at all. By default, the IRS sees LLCs as pass-through entities. Profits pass through the LLC to its members and the members pay personal income tax on their share of the LLC profits. However, LLCs can elect to be taxed as either S-corps or C-corps by filing a form with the IRS.
- Ownership Structure: LLCs are owned by members. Members are essentially partners. Each member owns a percentage of the company and splits profits based on that percentage of ownership. Should the managers not want to be in charge of daily operations, they can form a manager-managed LLC, and obtain a manager to run the business.
How To Form An LLC
LLCs are governed by the states and each state has its own statutes concerning LLCs. In general, the rules are congruent with each other and have similar requirements.
To form an LLC, you must file Articles of Organization (or similarly named formation documents) with the state’s Secretary of State or Corporations Division. Each state charges a filing fee averaging around $100. In many states, you can file Articles of Organization online.
While specific Articles of InLLC requirements vary by state, in general, you’ll need to include the following information:
- Business Name: Simply list the desired business name. Every state has an online name search database. If the name is not already in use, you can use it. You will also need to include a corporate name ending like “Inc.” : “Incorporated.” There is no need to reserve the LLC’s name, unless you will not be forming your LLC immediately and want to make sure the name is available at a future date.
- Business Address: List physical address and mailing address if separate.
- Registered Agent Name and Address: Your registered agent is the LLC’s official point of contact. Since the LLC has all the rights of an individual but is unable to communicate and receive communications, every state requires that you appoint a registered agent to do so on behalf of the LLC. If you hire Formed.com to form your LLC, we automatically provide a year of registered agent service for your LLC. We can also list our registered agent address for your business address for added personal security.
- Name and Addresses of Members: An LLC has a very simple ownership structure. The members of an LLC are the owners, and they are essentially partners. Each member owns a percentage of the company. List the names and addresses of the members as required.
- Member-Managed or Manager-Managed?: You can structure an LLC so that the daily operations are managed by the owners, or the owners procure the services of a manager who run the LLC on a day-to-day basis and the members make the big decisions about the company. A manager does not need to be a member of the LLC or have any ownership stakes.
- Name and Address of Organizer: The organizer is merely the person authorized to form your LLC. If you hire Formed to form your LLC, we would be listed as the organizer.
After completing the Articles of Organization, submit the filing to the state. Your state may have expedite fees if filing times are slow. Most states with online formation capabilities will file and activate your LLC immediately. Your LLC will be formed once the state has filed your Articles of Organization.
LLC Definitions and Terminology
While forming an LLC for the first time, you’ll likely encounter language you’ve never heard before. Don’t feel intimidated. Below, you’ll find in depth descriptions and definitions of legal jargon you may encounter along the way. Learn what this technical language is and how it applies to your LLC:
- Annual Report: To maintain your LLC and keep it in good standing, you will need to file an annual report or franchise tax with your state. Requirements vary by state, and some states have biennial reports or even decennial reports (Pennsylvania). In most states these reports are merely a verification of simple facts about the LLC and a filing fee, though, some states like Texas and Maryland require financial information and more intensive annual reports. In most states, you can file annual reports online. Due dates vary, however, most are based on the the LLC’s formation date.
- Annual Meetings: LLCs have no annual meeting requirements. Members do not need to have a meeting or record any decisions. They simply need to follow the constructs of the LLC operating agreement in order to make a change, though if you would like to record any decisions, Formed.com does include LLC resolutions templates should you want to keep track of changes.
- Articles of Organization: The formation documents filed with your state to form your LLC.
- Dividend: A distribution of net profit divided and distributed to the members after all operating costs have been covered.
- EIN: This goes by many names: Employer Identification Number (EIN), Federal Employer Identification Number (FEIN), Tax Identification Number, etc. No matter what you call it, this number is essentially your LLC’s social security number. It’s the company’s tax payer ID.
- Limited Liability: This term refers to the legal separation and distinction between an LLC and the members. The LLC is independent of the members and the LLC can own and hold property. Limited liability is what allows the LLC to be sued and not let the members’ personal assets be at stake.
- Members: The owners of an LLC.
- Operating Agreement: This document is very similar to a corporation’s bylaws. Most descriptions and web pages dedicated to describing how to form an LLC will focus on the Articles of Organization, but in truth, the guts of an LLC will always be found in the operating agreement. This document is not filed with any government agency. The operating agreement is an internal document that outlines and defines the rules of the LLC. The LLC operating agreement shows how profits and losses will be distributed to members; the roles of members and managers; how decisions will be made. The operating agreement is the LLC’s central nervous and circulatory systems. While operating agreements are not required by law in every state, every successful LLC will have adopted an operating agreement. For no additional cost, Formed.com includes an operating agreement template that can be adopted by your LLC, potentially saving you thousands in attorney fees.
- Organizer: The person authorized to form the LLC.
- Resolution: When the director’s or shareholders make a decision, sometimes even small one like deciding to open a bank account, the decision to do so must follow a decorum to maintain the separation between the owners and the LLC. When a decision is made, following the protocols laid out in the LLC’s bylaws, the decision will be recorded as a resolution. The resolution is recorded and kept, similar to meeting minutes.
- S-corp: S-corp status is a tax designation that LLCs and corporations can elect by filing a form with the IRS. This dramatically changes an LLC’s tax structure. The S-corp does not pay corporate tax, however, this creates an opportunity for members to distribute dividends at a discounted tax rate. However, S-corps are required to pay salaries possibly negating some tax savings abilities. S-corp status does not fundamentally alter any formalities within the LLC, as all protocols laid out in the operating agreement must be followed. S-corp status also restricts the number of members and doesn’t allow non-US citizen members. Formed.com can file your S-corp documents for an additional fee. To select this service, simply check the box on our incorporation signup form.
How Does An LLC Work?
The function of an LLC is to be a single entity through which multiple individuals can pool resources to do business. But actually describing how an LLC works requires a layered answer.
- LLC Formation ProcessOnce you complete the Articles of Organization, this document is filed with the state. The state then records the filing, making the LLC an active entity ready to do business.
- Internal LLC SetupAfter the LLC has been legally formed, the members must adopt an operating agreement. There are no formalities beyond this point with an LLC.
- LLC Formation LogisticsAfter the bank account has been opened, the EIN obtained, the real work begins. The LLC will begin doing business. For example, if the LLC’s purpose is to sell dog collars, the LLC will order dog collars and begin selling the dog collars. The initial investment capital from the members’ startup capital will be spent on inventory. The members or managers will oversee the daily business of selling the inventory. As profits come in, they will be deposited in the LLC’s bank account. Accounts should be balanced by the person in charge of accounting, taking care to balance what’s spent versus what’s earned. If the LLC ever requires additional funding, the members can decide to sell a percentage of the company to investors.
- Distribution of ProfitsAfter accumulating profits, the LLC will distribute net profits to members according to the percentage of ownership, or whatever arrangement was reached in the operating agreement. This cycle will repeat itself throughout the life of the LLC.
- LLC MaintenanceThe state where you form your LLC will have set maintenance requirements for your LLC. Most states have annual reports. These reports serve as a way update the state corporate database, which tracks the standing of businesses (good standing, inactive, active, etc.), as well as bring revenue to the states. The LLC will complete the annual report and submit it to the state. This cycle will repeat itself throughout the life of the LLC.
If the LLC should become entangled in a lawsuit and sued along the way, as long as a strict separation of assets has been maintained, no gross negligence, and there’s been none or very little co-mingling of personal funds and business funds, only the LLC can be found at fault and the members cannot be personally sued.
|Advantages and Disadvantages of Forming an LLC
|No corporate formalities
||Doesn’t have the fancy perception of a corporation
||Investors may be more wary of ownership in an LLC vs. stock in a corporation
|Flexible taxation options
||Doesn’t have the legal precedents of a corporation
|Ease of operation and maintenance
|| Fewer options for profit sharing with employees
Forming an LLC FAQ
How Do I Maintain a Corporation?
LLCs are the simplest business entity to maintain. Simply follow your state’s requirements—file reports with your state as required, etc—and pay your taxes. Notices and due dates will be sent to your registered agent.
At Formed.com, we’ll provide you will all templates necessary to maintain an LLC as well as provide annual report reminders and filing tips to ensure maintaining your LLC is as simple as possible.
Where’s the Best State to Form an LLC ?
In some ways, this is a trick question. Because of a variety of factors surrounding taxation, most often the state where you live is the best place to form an LLC. If you were to form an LLC in Delaware, but you live in California, California will likely require you to register as a foreign LLC in California, and negate many of the benefits of being incorporated in Delaware. That means more startup costs, additional maintenance, and more tax filings.
However, if you’re a non-US citizen or you have an online company with no employees, you can choose which state offers the most advantages.
Top 3 States To Incorporate In
- Wyoming: Wyoming is unmatched for its combination of taxes, privacy and tough limited liability statutes. It’s the birthplace of the LLC afterall. No corporate income tax. No personal income tax. Strong business asset protection laws. Business-friendly legislation. You can’t beat a Wyoming LLC.
- Delaware: Delaware will be at the top of the list for many simply by default. Delaware has a legal system to deal purely with business disputes, privacy (not required to list member information on public documents) and possible tax advantages.
- New Mexico: For many years, the state of Nevada was on this list, but increased taxes and annual fees created an opening. New Mexico has no annual fees for LLCs, however, if the LLC pays federal taxes, it must pay a $50 franchise tax to the state. Membership privacy is unmatched in New Mexico and the personal income taxes are low.
How Do I Do Business in a New State With My Corporation?
Anytime you begin doing business in a new state, you must register to do business in that state as a foreign LLC. Foreign LLC simply means you’re operating in a state other than the state where you originally formed the LLC. What constitutes doing business in a new state is somewhat debatable, but if your LLC has any physical presence in that state—an office with employees, company equipment or assets, etc.—you will likely have to register as a foreign LLC. The process to register to do business in a new state with an LLC is similar to the Articles of Organization. You file what is essentially new formation documents with that state, get another registered agent and services required to maintain good standing. You will also be required to pay taxes on profits gained from doing business in the new state and file annual reports with that state.