If you’re looking to start an LLC and form your business, you’re at the right place. Here you’ll learn how to form an LLC (Limited Liability Company) in the United States.
- How to Form an LLC in any State (Step by Step)
- What is an LLC (Limited Liability Company)?
- How an LLC Manages its Interests/Taxes
- Advantages & Disadvantages of an LLC
- Is LLC Formation A Right Choice?
Starting a new business is an exciting venture but it comes with a lot of responsibilities as well. We see many new businessmen opting for a Limited Liability Company (LLC) as their business model (by themselves or by hiring a reliable LLC service), but they are reluctant due to a lack of related knowledge or do not know how to do that.
Tip of the Day: Forming an LLC by yourself is mostly hectic, costly, and time taking. Hiring a reliable LLC online service or registered agent is not only saves your time but also budget-friendly. Therefore we recommend you to:
How to Form an LLC in any State (Step by Step)
Start your LLC Here in 5 Easy Steps:
- Select a State
Here, simply select the state you want to form an LLC in.
- Name your LLC (or reserve a name)
Obviously, you must name your LLC. You can also reserve the name if you see the procedure may take time.
- Choose a Registered Agent
You can choose a registered agent by yourself or hire a LLC services company.
- File the Articles of Organization (certificate of formation)
Articles of Organization, are the part of a formal legal document used to establish an LLC at the state level. By finding the best LLC service for you, we earn an affiliate commission to keep the lights on.
- Create an Operating Agreement
You can create an LLC without an Operating Agreement. But this documentation is necessary to avoid any future mess.
#1: Select a State
As in every State, there’s a possible procedural difference in forming an LLC. Therefore we’ve covered State by State guide to help you form an LLC. To start an LLC on your own, select your State below and follow the A to Z guide to form. If you don’t want DIY, find the Best LLC formation Services.
#2: Name Your LLC
Naming an LLC sounds pretty nice but that is nowhere near to naming your child. In fact, its not that easy as it seems. Mostly, the exact name is not always available. If you’re lucky enough to find the desired name of your company, there still some precautions you must take.
LLC documents filling takes time. So it’s better to reserve your LLC name by paying some extra bucks (reservation fee). It’s not illegal, nearly every state allows you to reserve a name for a short period of time by filing name reservation a form. Yet, the length of the reservation period varies state to state, and your efficiency. That’s why many people hire a registered agent or simply get LLC Formation Services online.
In addition, the name of your LLC must comply with the rules of the state you’re applying in. Because the company formation rules in the United States of America vary from state to state. For instance:
- Your LLC’s name must end with an LLC designator or of its abbreviation.
- LLC name must not be matching to any other registered LLC or business entity.
#3: Selecting a Registered Agent
A registered agent or a statutory agent is a person or sometimes a company that agrees to receive lawsuits, subpoenas, and other official & legal documents on behalf of the LLC on a physical street address in the state where the LLC is registered. Therefore every state requires its LLCs to name any registered agent.
The registered agent can be:
- A person who is a state resident
- A person must be over age 18 to serve
- A member or an officer of the LLC
- A private service company
A registered agent can be provided by a business formation company or you can hire a privately.
#4: Filing the Articles of Organization
Articles of Organization or certificate of organization, are part of a formal legal document used to establish a limited liability company (LLC) at the state level. That is why to create your LLC, you must file articles of organization.
This Organizational Paperwork is filed with your state’s corporate filing office, often the Secretary of State (or in some state. You can fill the article of organization online. The information to be filled may include:
- The name of an LLC
- The address of an LLC
- Details of the registered agent such as the name and address
- The names of the LLC owners
- The objective why the LLC was formed
- How it will be managed
- And the length of its existence
The paperwork must be signed by an LLC formation company representative, registered agent, or whoever the person forming the LLC. As for the charges, all states charge a filing fee, but the LLC cost varies from state to state – mostly around $100. You’ll have to pay a filing fee when you submit the articles.
#5: Creating an LLC Operating Agreement
An LLC Operating Agreement is an internal document that defines how your LLC will be run, which includes:
- How will it be managed?
- How profits and losses will be allocated?
- The ownership interests
- Voting rights of the members
- How and who will govern the company
- What happens if the member dies
- What to do in case of any member leaves the business
- Law on dissolving a company
- And much more
In fact, you can mention anything that is needed to secure the rights and responsibilities of the members & the company to minimize future disagreements.
That is why most states don’t require an LLC Operating Agreement to form an LLC. It is all about an effort to let things define to avoid any mess in the future. Because in the absence of an operating agreement, state law will govern how your LLC operates.
If you feel it hard to file an Operating Agreement, you can also sign up for an affordable LLC formation service.
What is an LLC (Limited Liability Company)?
An LLC is a legal business model that combines the characteristics of a sole proprietorship, a corporation, and a general partnership.
For instance, an LLC can be formed and managed by a single person as it is done in sole proprietorship.
On the other hand, an LLC has the perks of corporate personhood such as it can hire employees, have a bank account, buy property etc. More importantly in case of any legal trouble or unforeseen business circumstances, the creditors can not claim the personal assets of the owner/s of the LLC.
There are, however, some differences between LLC and corporation or sole proprietorship which make LLC a distinct business entity. For example, an LLC is a more formal business structure than that of a sole proprietorship.
Personal assets are not liable in case of LLC whereas in sole proprietorship creditors can claim the personal assets as well along with the business assets of the owner.
Similarly, an LLC is different from a corporation in many ways. The owners of an LLC are called members and while in the corporation they are called shareholders. Unlike the shares of a corporation, membership of an LLC can not be sold or easily transferred.
An LLC can not generate revenue by selling stock like a corporation does rather external investments off the LLC come from other sources.
Moreover, an LLC does not have to do extensive paperwork and maintain detailed records such as meeting minutes, ledgers, bylaws, etc. instead, it just needs to file an annual report and few other items. Considering all these features, people now prefer an LLC over other business structures.
For more details, you can learn more on what is an LLC from here.
How an LLC Manages its Interests/Taxes
LLC is very flexible in terms of choosing the route to pay income taxes and in deciding how financial interests will be split up among the members.
An LLC often enables the transfer of the ownership interests to their family members that are more tax-advantaged. The following are the possible choices for an LLC to choose its taxation process.
- As a sole proprietor or straight partnership model
- As an S corporation model
- As a C corporation model
A) As a sole proprietor or straight partnership model
According to this taxation model, the LLC does not need to file its own tax return rather it is just required to submit a report containing information related to profit or loss through the LLC business.
All members of the LLC will receive the income as per the operating agreement of the LLC and then each member will pay the tax on his individual tax return. The net income of each member will also be subjected to payroll or self-employment tax under the Self-Employed Contributions Act (SECA). Overall, the total payable tax in this model is less than that of a corporation.
B) As an S corporation model
If an LLC chooses to pay its tax through the S corporation model, there will be no maximum limit of members, unlike actual S corporation where only 100 shareholders (all should be US citizens) are allowed.
S corporation may provide some tax savings than that of a C corporation. Shareholders of S corporation do not pay SECA tax on their income, but each owner should pay them a reasonable salary which is subjected to Medicare and Social Security taxes under the Federal Insurance Contribution Act (FICA).
C) As a C corporation model
If an LLC classifies itself as the C corporation model, LLC will be a taxable entity. This means the LLC itself is taxed on its income unlike the above stated two models, where income is passed among the owners and then it is taxed.
With this model, members will be subjected to double taxation as the income is taxed on the company level and then each member will be taxed on the individual level once the funds are transferred. Such a model will be beneficial for the high-income members of LLC who can save money by having lower personal tax brackets.
Advantages & Disadvantages of an LLC
Like any business entity, an LLC also has some pros and cons. Regardless of that, an LLC is equally popular among small- and large-scale businesses. Here are the positive and negatives features of an LLC.
Pros of a Limited Liability Company
1) Restrained liability
In an LLC, personal assets of a member are not subjected to any lawsuit or debt due to corporate veil. This veil shields the personal assets of a member from creditors by drawing a line between financial and personal assets.
In case of sole proprietorship, the owner’s personal assets are liable in case of any debt or legal trouble and company’s finances are not sufficient to compensate those debts or legal proceedings. Some of the liabilities against which a member of LLC is shielded are
- Damages: If someone gets hurt by the business or property owned by you
- Unpaid business debt: Unless any member guarantees those debts
- Vendor disputes: If a member is billed more than he/she owes
2) Easy startup and administration
It is incredibly easy to file your case with the state government online and pay the fee through your credit card. This process takes relatively less time to complete than that of the other formal businesses usually take.
You can further cut down the time using the registered agent services. This will allow you to focus on your business and these agents will apply and do the rest of the paperwork on your behalf.
One of the basic requirements in the formation of LLC is to draft and file your Article of Organization with the state government. This process is relatively easy in case of LLC while the other formal business entities need to go through many legalities.
Apart from the article of organization, to govern the operation of the LLC, an Operational Agreement is needed. This Operational Agreement defines the obligations and rights of the members of LLC to each other. For this purpose, one can consult an attorney for legal advice for more customized needs or help can be sought from the drafts available with online business formation services.
Ongoing requirements come on annual basis and an LLC is just needed to submit an annual report and annual fee (required by some states). LLC has relatively simpler ongoing compliance requirements than the other formal business entities.
3) Lesser paperwork and formalities
One of the interesting features, that make an LLC the most popular business model is that there are fewer formalities and paperwork in LLC in comparison to a corporation. Even it requires more time and effort to establish a corporation and a huge list of prerequisites is there to file for a corporation while the LLC formation process is not considered a nuisance.
A corporation is required to conduct meetings of board members and shareholders on a regular basis while LLC members meet at their discretion.
There are legal obligations on a corporation to maintain business ledgers, meeting minutes and related stuff while an LLC does not have such laws to follow. The bylaws are strict in a corporation while in an LLC they are relatively flexible.
4) Flexible Managerial Structure
In many states, by default, an LLC is member-managed. But an LLC has been given the choice to be managed by its members, or by a Manager who can be an outsider or can be a member. Hence, the owners share the day to day decision making if they opt to be managed by the members. In case the members are not expert, they can hire experienced people to do this task for them.
There is a rigid management structure in a corporation where shareholders, the board of directors and appointed officers have their distinct roles.
5) No restriction on number of members
An LLC can be startup with any number of members and there is no limit to the number of memberships. An LLC can be single-membered, multi-membered or can even be owned by other LLCs as well resulting in a multi-layered company. Such a multi-layered company strategy works best in case of
- Pharmaceutical Company
- Product segmentation
- Branded retail Products
- Real estate
- Marketing firm
In case of an S corporation, there is an upper limit of 100 shareholders, while a sole proprietorship is owned by a single person.
Moreover, there is a restriction of citizenship, US national in the case of S corporation whereas in an LLC you don’t need to worry about who can be a member of LLC and who can’t. An LLC member can be a foreign investor, allien or US citizen.
6) Freedom to choose Tax structure
The owners of LLC, unlike other business structures, can decide how they want to be taxed. A big chunk of the business community chooses to pay tax as a pass-through method. About 95% of US businesses are taxed as pass-through entities.
LLCs usually choose to pay tax via pass-through approach in which LLC does not pay tax itself, rather business income is passed through the members and then tax is paid through the individual’s personal tax return.
An LLC may choose to pay tax as S corporation to and enjoys certain tax benefits. For example, LLC members can pay themselves a salary and without paying self-employment tax.
Additionally, in the S corporation tax model, the second layer of tax can be exempted. In case of members with high income, where corporate tax is lower than the individual tax brackets, an LLC can choose to be taxed as C corporation.
7) No restriction on the pay of members
An LLC has an extraordinary flexibility in allocating the profit or loss to the members in different amount. There is no restriction of LLCs regarding how they pay and how much they pay their members.
A member can be paid higher or lower than his share of ownership. In addition to that, there are tax write-offs, which can be more or lesser, for expenses related to business and reimbursements for those expenses which a member paid personally through guaranteed payments.
In the case of single-membered LLC or an LLC owned by a married couple, who file joint tax returns, all deductible expenses and taxable revenues will be passed along the sole owners.
Unlike the corporation, the IRS does not recognize the LLC’s right to pay its members a salary. Salaries paid to the shareholders of a corporation are deductible against the corporate profit whereas in LLC such payments are considered as draws and are not considered against partnership income.
Cons of a Limited Liability Company
1) Repercussion of a member turnover
In some states, in case a member dies, leaves the company or goes bankrupt, the LLC must be dissolved. The remaining members become responsible for the financial and legal obligations that are necessary in the termination of the business. The remaining members can continue their business under a new LLC.
2) Hindrance in raising funds through investment
Unlike corporate business, an LLC cannot sell stocks. To raise capital, an outside investor can only invest after buying the membership of the LLC. Due to the pass-through nature of an LLC and flexibility in the management outside investors prefer to invest in a corporation.
3) Self-employment and excise taxes
If you create an LLC in a state other than your residence, that states may put a franchise/excise tax or business levies. Depending upon the state in which an LLC is doing business, an LLC can be taxed up to 7.5% self-employment tax.
To exempt the self-employment tax on profits, LLCs chose to be taxed as an S or C corporation. In this case, the members have to pay 7.5% self-employment tax on their salaries.
In short, if the LLC members chose to be self-employed, they will be subjected to more than 15% self-employment tax rate which includes employer and employee part of Social Security and Medicare. But of the chose to be taxed as a corporation, tax amount should be reduced to 50% by exempting employee tax.
4) Licensing fee and legalities varies state to state
While starting up a new LLC, filing fee ranges from $50 to &500 depending upon the state an LLC wants to operate. The annual filing fee also varies state to state ranging from $0 to $820.
However, you do not need to start an LLC in the state you live, you can pick any state which is business-friendly and make sense for your business. If an LLC operates in multiple states, it could be difficult to extrapolate what is expected from the LLC, given that an LLC makes its own guidelines while in a corporation, operational guidelines are fixed.
5) More paperwork/requirements than an informal business
It requires more paperwork and formalities to initiate your business as an LLC than in the case of general partnership or sole proprietorship. Moreover, informal businesses do not need to pay fee, maintain documents and submit an annual fee.
To get rid of this problem, most of the LLCs are hiring registered agents providing the best LLC services to do such paperwork for them.
Is LLC Formation A Right Choice?
- For the entrepreneurs, who want to set up their business as a standalone or restrict their liabilities, give the business the ability to survive on its own and segregate their personal and business finances. In this perspective, an LLC is the easiest and most economical formal business entity.
- For the owners who want a flexible tax treatment, and malleable management structure, an LLC is a perfect option for them as well.
- In case of a business where owners are not sure where they need liability or a large business that requires a more robust structure, or for certain licensed professionals an LLC may not be a good business model.