What Is an LLC?

An LLC is a a limited liability company, a type of business entity formed with the secretary of state in your state.

What Is an LLC?

To explain what an LLC is, let’s break down the term “limited liability company” into its two components: Fundamentally, an LLC is a “company” that offers “limited liability” for its owners.

An LLC is a Company

An LLC is a company, so it is a separate entity from you, its owner.

So if you don’t have a business entity set up — whether an LLC or a corporation or a partnership — then when you go out and do business, you will be doing business as you, a person.

Sure, you might have a DBA, but you’re still doing business as you.  Contracts and other official documents, for example, will be made in your name.  Your 1099s will be issued to you.

But once you start an LLC, it’s your entity — not you as a person — entering into contracts.  Sure, you may still sign these contracts as a member of your LLC, but it’s your LLC that is entering into contracts, not you.

An LLC Can Offer Liability Protection

Beyond simply being a separate entity from its owners — that is, a company — an LLC is also a limited liability company, meaning that it can theoretically offer you liability protection.

This means that if your LLC gets sued, your personal assets could theoretically be protected — and I say theoretically because very often this doesn’t work as well as an LLC owner might think it does.

Now, an LLC is not the only kind of company you can set up that can theoretically offer liability protection.

Just like you can go to your state’s secretary of state website and set up an LLC, you can also set up a different kind of entity such as a partnership or a corporation.

Now, partnerships require at least two partners in a partnership, and even then they may want to form an LLC rather than a general or limited partnership anyway.  But if you’re a solopreneur, a partnership wouldn’t work for you anyway since you’re only one person, so you’re left with deciding between an LLC or a corporation.

The reason that so many solopreneurs form LLCs rather than corporations is that LLCs are typically less complicated and less costly to set up and maintain than a corporation.

Check out my latest YouTube video for expert insights and practical tips on how forming an LLC can save you money and protect your assets

How to Start an LLC

On the one hand, setting up an LLC is rather simple: You file some documents with your secretary of state, pay some fees, and that’s that.

But on the other hand, how you set up your LLC can have significant tax and legal ramifications, which is why you may want to consult with both a tax professional and an attorney in your state to make sure you have your bases covered.

That said, here are the steps involved in setting up an LLC.

Step 1: Figure out your LLC’s name.

The first step in creating an LLC is determining what to name it.

Check with your state, of course, but most states require LLCs to end with one of the following:

• LLC
• L.L.C.
• Limited Liability Company
• Limited Liability Co.
• Ltd. Liability Company
• Ltd Liability Co.

And once you’ve decided on a name, you should make sure it hasn’t already been taken in your state.  Most states’ Secretary of State websites have a lookup tool that you can use to look up other LLCs to make sure the name you want for your LLC isn’t taken.  For example, here’s California’s business search.

Step 2: Choose your registered agent.

Your LLC needs a registered agent in the state you are forming your LLC in.  This is someone someone who is available during normal business hours to accept legal papers.

While you could be your own registered agent, you may not want to be.

I don’t know about you, but I’m not at my business all the time.  I like to work at coffee shops, I like to go on vacation, and some days I like to stop working at two o’clock in the afternoon to go hang out with my kids.

Who’s going to accept these legal papers if I’m not there?  This is where the registered agent comes in.

There are plenty of affordable companies out there who can serve as your registered agent so you don’t have to.

Step 3: Decide if your LLC will be member- or manager-managed.

A major decision you have to make before you form your LLC with your state is whether the LLC will be member-managed or manager-managed.  This is because the articles of organization you file with your state will ask you this question.

In general, if your LLC is member-managed, all the members of the LLC make decisions for the business

If your LLC is manager-managed, that means that there is a person or persons who can make decisions for the LLC, enter into contracts for the LLC, etc.  These managers can be LLC members, a third party, or even another business entity.

Now, if you’re a solopreneur who is basically doing everything in the business yourself right now anyway, and you are the only member of your LLC, this distinction may not matter as much to you right now, at least superficially.

But there might be some planning aspects here and other questions to consider.  For example, what if you pass away?  What if you want to step back from the business eventually and hire others to manage the LLC’s affairs?

These questions are why you might want to consult with a business attorney before forming your LLC yourself.

This distinction between member-managed and manager-managed is important not only for the day-to-day functions of the LLC today but can also create future issues tomorrow.  For example, if you’ve indicated that your LLC is member-managed when for all practical purposes it is being managed-managed, that could be one factor in favor of a court piercing the LLC’s corporate veil in a lawsuit, leaving your personal assets exposed.

Step 4: File your LLC’s articles of organization.

The articles of organization are the formation documents filed with your state to form your LLC.

States generally have a standard form that business owners can use to file their articles of organization.  For example, California has Form LLC-1.

Many states allow users to file their articles of organization online.  For example, here’s California’s online articles of organization submission page.

Each state’s articles of organization have a different format, but they all generally ask for similar information.

The table below indicates some of the most common information required to complete your LLC’s articles of organization.

Step 5: Pay the filing fee.

Each state has a different fee that business owners must pay in order to form their LLC.  Here in California, for example, the filing fee is $70.

Step 6: File any other required forms.

Your state may (or may not) have other forms that are required to be filed after you file your articles of organization.

For example, here in California, within 90 days of filing the LLC’s articles of organization, business owners must file Form LLC-12 as well, which comes with a $20 filing fee.  California LLC owners must also file this form every two years for as long as their LLC exists.

Step 7: Draft your operating agreement.

This isn’t something you submit to your secretary of state, but it’s still a very important part of your LLC formation process.

This document essentially governs how your LLC runs.

Should You Form Your LLC Yourself?

The steps outlined above are how to set up an LLC by yourself.

That set, before you go the DIY route with your LLC, know that there are some things you need to think about and perhaps get guidance about from a lawyer about before you set up your LLC.

One example is the member-managed vs. manager-managed issue described above.

Also important is knowing how to maintain your LLC, how to separate your LLC’s finances and your personal finances, and other important tasks that if not done correctly could compromise the liability protection your LLC can offer you.

The last thing you want is for, in the course of a lawsuit, a court to look at your LLC and say, “This is a sham.  The owner of this LLC commingled business and personal finances and never really treated the LLC like a separate entity.”  This is called piercing the corporate veil, in which case the court could essentially disregard that LLC for liability protection purposes, leaving personal assets are exposed.

If you have more questions about this, I’d recommend that you consult with a qualified business attorney in your area.

Do LLCs Give You Tax Benefits?

As a CPA, I get this question a lot: “Will setting up an LLC save me on taxes?”  It’s cliche, but the answer really is, “It depends.”  Let me explain what I mean.

LLCs don’t let you deduct more expenses.

Well, for the most part, if you’re a single-member LLC — meaning you’re the only member of your LLC and your LLC hasn’t elected to be treated as a corporation for tax purposes — then you will report all your business income and all your business expenses on Schedule C of your tax return (or, in the case of rental income and expenses, on Schedule E) just like you did if you didn’t haven an LLC.

And generally speaking, having an LLC doesn’t entitle you to any additional deductions or credits than if you didn’t set up your LLC.

For some reason — and I think this has to do with vague information coming down from a lot of the “Start Your LLC Now!” shops you see online — a lot of people think you need an LLC to deduct expenses in your business.  But that’s just not true; you can deduct legitimate business expenses against your business income whether you have an LLC or not.

Electing S corporation status for your LLC may save you on taxes.

Now, one way that an LLC can save you money on taxes is if your LLC elects to be treated as an S corporation, which can save you a bit on the Social Security and Medicare taxes that you have to pay on your business income.

Of course, your business definitely has to be at a certain point for electing S corporation status to make sense.

An S corporation could cause you to pay more in state taxes.

Also, if you live in a state that imposes annual taxes and fees on LLCs, an LLC could even cause you to pay more in taxes.

For example, all LLCs formed or registered in California must pay an annual LLC tax of $800 in addition to an annual LLC fee that ranges between $900 and $11,790 depending on how much California gross receipts the LLC has.  LLCs with less than $250,000 in annual gross receipts sourced to California don’t have to worry about the fee, but they must still pay the $800 tax on an annual basis.

Thankfully, not all states charge as onerous fees on LLCs as California does — and most don’t charge these annual taxes at all — but my point is that before you rush into creating an LLC you should check with your state to see what kind of taxes you’ll have to pay on your LLC.

So does an LLC save you on taxes?

Depending on your situation and what state you’re in, an LLC could help you taxwise, it could do nothing for you taxwise, or it could hurt you taxwise.

It really does depend.

And on top of taxes, there are other fees that you may have to pay to the state periodically. Again, using California here as an example, every two years LLCs have to file a statement of information, Form LLC-12, with the Secretary of State, which has a $20 filing fee.  This isn’t a huge deal, but it’s just another cost and administrative task on a business owner’s already-full to-do list.

LLC Advantages and Disadvantages

Setting up an LLC isn’t necessarily the right move for every business owner.

There are certainly advantages of having an LLC for your business, but there are disadvantages as well, and these have to be weighed against each other.

Here are the major advantages of LLCs:

• Possible liability protection if your business gets sued
• Lends a degree of credibility to your business
• Possible tax benefits if you elect S corporation status
• Relatively easy to setup and maintain, at least compared to a corporation

And here are the major disadvantages of LLCs:

• Cost money to set up an maintain
• Come with legal pitfalls, just like any business entity
• LLCs tend to get a lot of spam mail (and even scam mail)

Should You Form an LLC?

Forming an LLC is not a decision to be made lightly, regardless of what the “Start Your LLC” websites say.

If you would like professional assistance in determining whether an LLC is right for your business, email me at [email protected].