Limited Liability Companies For Dummies
Overview
There’s no better time than now to start a new business and tap into the power of the LLC
LLCs For Dummies is your comprehensive guide to limited liability companies. You’ll explore whether an LLC is the right business structure for your business, how to set up a corporate structure and membership, and the best ways of managing an LLC. Author Jennifer Reuting explains the pros and cons of LLCs and shares insider tips on choosing members, selecting a company name, creating and filing Articles of Organization, managing day-to-day operations, and beyond. This updated edition covers all the latest tax and regulatory information, plus new laws that make it more attractive than ever to start your own business. You’ll also find real-world advice on customizing your LLC for your specific business needs, creating a great operating agreement, keeping accurate records, and filing the proper paperwork with Uncle Sam.
- Learn to start a new business by founding a limited liability company (LLC)
- Get a handle on the differences between LLCs and other business structures, including state-specific tips
- Keep up on the latest information on federal taxes, regulations, and fees
- Discover online tools, new documents and forms, and helpful resources
Anyone who wants to learn the best practices of LLC formation, management, and long-term growth will love this beginner-friendly Dummies guide.
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About The Author
Jennifer Reuting is a renowned LLC expert and entrepreneur with more than two decades of experience in guiding individuals and businesses through the complexities of limited liability company formation. As the founder of CorpAssure, she combines her extensive knowledge and practical experience to make the process of forming and running an LLC accessible and straightforward for small businesses and first-time entrepreneurs.
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limited liability companies for dummies
CHEAT SHEET
Individuals are now, more than ever, realizing the power of the limited liability company (LLC). If you’re like many people, you probably understand that an LLC can benefit you somehow; you just don’t know the next steps to take.Read on to find out the benefits of LLCs, get help naming your LLC, and get the lowdown on the different tax types for LLCs so you can make the best decisions for your business.
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Limited Liability Companies (LLCs) are flexible — you can use them for practically any purpose — and they offer more benefits than any other entity type. They have a favorable pass-through tax status, and with the dual liability protection that LLCs offer, corporations and limited partnerships can’t compare. Following are some good reasons to form an LLC.
LLCs (limited liability companies) are pretty powerful entities that you can do some pretty amazing things with. But you know how the old saying goes: "With great power comes great responsibility." In other words, if you don't watch out, you can get yourself into trouble.
Fraudulent conveyance of assets
If you just got sued and want to protect your assets, I'm sorry to say that it's too late.
General Small Business
Now, really, what is the point of a limited liability company without the limited liability part? Without limited liability, it’s no better than an expensive sole proprietorship — no special protections, no special tax treatment, no ability to issue shares of ownership.
If you don’t take the simple steps necessary to keep your limited liability intact, you may as well save yourself the filing fee for creating your LLC and be prepared to kiss your hard-earned personal assets goodbye if you’re sued.
General Small Business
An operating agreement is a contract that controls how an LLC (limited liability company) operates and how the members interact with the LLC. You might think that as a sole owner of a company that no operating agreement is necessary — after all, operating agreements are comprised of terms agreed to by all of the members, and well, why make an agreement with yourself?
Everyone seems to be going crazy over limited liability companies (LLCs), and for good reason. The LLC is one of the most flexible entities — you can choose how to distribute the profits, who manages the business’s day-to-day affairs, and how the profits are taxed. The LLC also offers a lot in terms of liability protection (hence the name limited liability company).
General Small Business
All businesses must obtain an employer identification number (EIN for short, but also called a tax identification number or tax ID) from the Internal Revenue Service. The IRS uses this number to identify your limited liability company (LLC) when the LLC pays its taxes.
Over the years, the EIN has become an important number for the government, financial institutions, and other businesses to identify different entities.
General Small Business
If you’re selling tangible goods, then you’re required to collect sales tax from your customers and pay the government. What is a tangible good? Although the definition may vary slightly between states, you can pretty much classify a tangible good as being any item that can be seen, weighed, measured, felt, or touched or is in any other manner perceptible to the senses.
Business liability insurance is a good way to help protect yourself. These insurance policies add an extra layer of protection . . . the key word being extra. Most insurance policies have disclaimers a mile long and aren’t too keen about paying out in a timely manner.
Also, having insurance tends to encourage lawsuits rather than deter them.
General Small Business
Assuming your limited liability company (LLC) isn't operating in multiple states, changing the name of your LLC is usually a fairly easy process. However, there are a few things to consider.
First, you should ask yourself whether or not changing your LLC is absolutely necessary, or if you could simply get by with the much easier process of filing for a DBA or "doing business as" (also often referred to as a "fictitious firm name" filing).
As the owner of a limited liability company (LLC), you have the unique ability to choose how you want to pay taxes on your business. LLCs can be taxed as partnerships (with pass-through taxation) or as sole proprietorships (if the LLC has only one member); or they can even choose to be taxed as a corporation or an S corporation.
General Small Business
Humans aren’t just vocal and aural beings; they’re visual, too. So, unless your target demographic is of the nonhuman variety (not likely!), you need to take into account the visual element of your limited liability company's brand: your logo.
Logo designs come in four basic forms:
Word mark: Your company name in a specialized typography is your logo.
It’s a common myth that you need to form your limited liability company (LLC) in the state in which you live. LLCs are considered incorporated entities, which means that if you maintain them properly, a layer of separation exists between the business and the owners.
Think of an LLC as an individual over which you have full control.
General Small Business
If you’re currently operating as a corporation, converting to a limited liability company (LLC) is a clear, good move unless you plan on going public or raising venture capital. The double taxation inherent in corporations is rarely helpful for a growing business. Unfortunately, as good a move as the conversion to an LLC is, especially where taxes are concerned, it can also be a pretty hairy process.
General Small Business
The conversion to an LLC (limited liability company) from a general or limited partnership is probably as straightforward a switch as you can get. No matter whether you’re a general partnership, limited partnership, or limited liability company electing partnership taxation — you’re all the same in the eyes of the IRS.
General Small Business
Considering that the most common, albeit dangerous, method of operating a business is as a sole proprietorship, you may well be running a sole proprietorship currently. Although sole proprietorships are easy and cheap to start, they offer zero liability protection, and they give your customers and employees little confidence in your business acumen.
General Small Business
Whether you’re a single-member LLC or you have multiple members, you can always elect to be taxed like a corporation. Corporate taxation is completely different from partnership taxation.
First and foremost, the IRS considers a corporation (or an LLC electing corporation tax status) to be an entity completely separate from its owners and treats it as if it were an individual.
General Small Business
If this is your first venture, you may think of all corporations as massive multinational conglomerates, but that isn’t the case. Corporations have been around for centuries and, until the recent introduction of the limited liability company (LLC), were the only business structure that allowed entrepreneurs to start ventures without opening themselves up to heaps of personal liability.
General Small Business
Finding out whether the name you want for your limited liability company (LLC) is available is difficult, mostly due to the level of fortitude it takes to scratch a beloved name or two off your list when you find that it’s unavailable for use. As difficult as parting with some of your favorites may be, you must do so if they’re already in use.
General Small Business
The disregarded entity tax status is the default for single-member LLCs. Essentially, it’s the same tax status you’d pay as a sole-proprietorship (as if you haven’t filed your LLC at all). It’s the one form of tax status that LLCs with multiple members can’t elect.
Similar to partnership taxation, disregarded entity tax status is a form of pass-through taxation, and in this case the sole member pays personal income taxes and self-employment taxes on the company’s profits and/or losses on his personal tax return.
General Small Business
Although you do have autonomy in choosing your business name, the state has some requirements that you’ll have to keep in mind, namely (no pun intended) that you must designate your business as a limited liability company. You do so by adding the designator limited liability company, limited company, or an abbreviation such as L.
An LLC can be formed in any state you wish, but if your LLC conducts business elsewhere, it must register to transact business in those states.
“Conducting business,” refers to serious business, such as hiring employees and leasing office space. Simply selling your products or services to folks in a certain state doesn’t count.
General Small Business
You can't expect to pick a great name for your LLC (limited liability company) out of thin air. Creativity is best served when subject to a few helpful restrictions. The following are a few naming rules for your businesses:
Be distinct. Naming your brand-new and improved social media site FaceSpace or MyTube won't give the impression that you are either "new" or "improved.
Think of an limited liability company (LLC) as a partnership on steroids. If you and a buddy were to get together and start a business without registering it as any particular business structure with the state, your business would automatically be considered a general partnership.
All business income and losses would be reflected on your personal tax returns.
General Small Business
LLCs (limited liability companies) are the perfect tool for planning an estate. Planning your estate is sort of like shooting at a moving target — you can't plan for a future that you are unsure of. Nothing is certain in estate taxes, and Congress may pass another tax act in the coming years that changes the estate tax structure.
General Small Business
Businesses don’t operate themselves — someone needs to manage them! You don’t have to decide immediately exactly who will manage the day-to-day operations of your business and what their specific roles will be, but most states require that you give a basic idea of how your company will be managed in the articles of organization.
If you elect partnership taxation for your limited liability company (LLC), you’re assessed a 15.3 percent self-employment tax in addition to the personal income taxes you’re required to pay on the profit that’s allocated to you.
In addition, even if you’re an active member of your LLC, you aren’t allowed to hire yourself and use payroll taxes as a way to get around the hefty self-employment tax bill each year.
General Small Business
Although you can decide on your own how your limited liability company (LLC) behaves upon a member’s death, the law always protects the remaining members’ interests, especially from the passing member’s heirs.
Because membership shares of LLCs are considered personal property, those shares will go through estate and probate much the same as the other assets of the deceased.
General Small Business
After your new limited liability company (LLC) is set up and all the assets and contracts have been transferred from an old business structure, you can begin winding up the affairs and dissolving your old business structure.
If you were operating as a sole proprietorship or general partnership and you have executed a statutory conversion, which simply transforms your current entity into a limited liability company, you do not need to dissolve the old entity.
General Small Business
Finding a registered agent isn’t too difficult. Finding a legitimate one that can and will do the job for a reasonable price is another story altogether. The best way to find an agent is to call your secretary of state’s office and ask for a recommendation. Some state offices will give you some names; others try to remain impartial.
After a limited liability company (LLC) starts turning a profit, the members will no doubt want to benefit. After all, they didn’t invest their hard-earned money in the company for nothing — they want to see a return!
At certain times — usually at the end of the year, but sometimes at the end of each quarter — company profits can be calculated and doled out to each member, usually in proportion to her percentage of ownership.
When you buy a share of stock on the stock market, the money you pay is what you are contributing (or investing) in return for a percentage (or share) of the company’s ownership. Well, purchasing ownership in an LLC is very similar: In exchange for a membership interest in the company, a person or company must contribute something of value.
Just because you own it doesn’t mean that you need to know what to do with it. Limited liability companies (LLCs) have a manager role — a person who handles the day-to-day operations of the company. All LLCs are required to have at least one manager. They can be the owners themselves or other outside persons or businesses.
General Small Business
So now you know that an LLC protects your personal assets if the business gets sued or goes bankrupt. Pretty great, eh? Well, it gets even better. Unlike corporations, LLCs have a dual layer of liability protection called charging order protection.
Many moons ago, when a creditor obtained a judgment against a partner of a partnership, the creditor could simply take the partner’s interest in the business (and, proportionally, all related assets) and liquidate them in order to get paid, often leaving a ravaged business in his wake.
General Small Business
Individuals are now, more than ever, realizing the power of the limited liability company (LLC). If you’re like many people, you probably understand that an LLC can benefit you somehow; you just don’t know the next steps to take.Read on to find out the benefits of LLCs, get help naming your LLC, and get the lowdown on the different tax types for LLCs so you can make the best decisions for your business.
General Small Business
One of the biggest causes of discord among partners is when one or more don’t live up to their ends of the bargain. When a partner agrees to provide certain value to the company (namely, in the form of services) in exchange for a certain percentage of the membership, he’s expected to make good on his promises.
General Small Business
Many LLCs restrict the transfer of ownership. Although this restriction used to be a requirement of LLCs, it is now more customary than anything else. Basically, if a member wants to sell or transfer her shares, she can only assign the economic rights to the ownership, not actually transfer it.
So the person purchasing the membership only has rights to the profits that are distributed; he has no voting rights and no control over the business’s operations.
General Small Business
You may think that having boundless options gives you a better chance of coming up with a great name for your LLC, but think again. After all, creativity is better served when it’s subject to a few (helpful) restrictions. Before you let the ideas fly, check out a few naming “rules” gathered from industry experts:
Be distinct.
General Small Business
After you form your LLC, you’re ready to start business operations, right? Not even close. Actually, your work has just begun. After you’re registered, you still have to complete the formation of your LLC by creating your operating agreement and making some very important decisions. Luckily, you can handle most of these things while you’re waiting for your filed documents to come back from the state, saving you time.
General Small Business
All LLCs are created with a default tax status. If your LLC has at least two partners and the LLC doesn’t make any tax classification election with the IRS, then your LLC is automatically assigned the default, which is partnership taxation — a favorable form of pass-through taxation.
The various forms of pass-through taxation have some differences, but the premise remains the same: The business itself doesn’t pay federal income taxes; instead, the profits of the business pass through to the owners to be reported on their individual income tax returns.
General Small Business
LLCs are becoming more and more popular in estate planning. Trusts are still king, but now they’re generally used in conjunction with LLCs so that your assets are protected while you’re still alive. A trust usually doesn’t provide any asset protection whatsoever, whereas an LLC provides dual liability protection.
General Small Business
Preparing the articles of organization for your limited liability company (LLC) can easily end up being overwhelming — especially if the state rejects your articles a number of times. But keep your chin up. If you stay organized and get helpful assistance, you should be able to get your articles submitted within a couple of days and be certain that they will be filed without incident.
General Small Business
With most entities, if a shareholder owns 10 percent of the company, he can receive only 10 percent of the profits that are distributed, no more and no less. With an LLC, you have freedom to choose! You don’t have to split the profits in accordance with the percentage of ownership.
If all the members agree, and you have a legitimate reason for doing so (the IRS won’t accept tax evasion as a legitimate reason!
General Small Business
As the adage goes, “You aren’t in business until you’ve been sued.” As litigious as society is these days, you don’t even need to be one of the bad guys to be dragged into court.
By simply transacting business with the general public, you open yourself up to myriad potential lawsuits, and no matter how arbitrary the complaint is, the destruction (and legal fees) it leaves in its wake can be crippling.
General Small Business
Tens of millions of Americans operate small businesses. They range from small, home-based side businesses to fully operational companies with many employees.
For the most part, these individuals operate without protection. Granted, they may not take what they do too seriously. They may consider themselves independent contractors or consultants, but in today’s litigious society, operating without even a basic level of liability protection is a bad move.
One of the primary concerns of starting a new venture is acquiring capital. This need for cash can be a game-changer when it comes to selecting an entity type for your new business.
If you seriously intend to go after private equity (venture capital, institutional investors, and so on) or raise money through an initial public offering (IPO), then there’s a chance that you’ll want to form your business as a corporation rather than a limited liability company.
General Small Business
You can do nothing worse than hold investment property in your own name. Please read that statement again and again until it’s a mantra that keeps repeating in your head. So now that you know you need some kind of entity to protect your investment real estate, you can compare corporations to LLCs.
Knowing when corporations can kill
The limited liability company has an acute advantage over all other entities when it comes to holding real estate.
General Small Business
Because LLCs (limited liability companies) are allowed to elect pretty much any tax status that suits them, the federal returns, information statements, and notices that they are required to file each year vary accordingly. An LLC can choose the following types of taxation: disregarded entity, partnership, corporation, or S corporation.
Like all business structures, limited liability companies (LLCs) are governed by the individual states. Some states are progressive and comprehensive in their laws governing LLCs, whereas others have laws that seem to be last updated in the 1990s.
In contrast, corporations have been around for centuries, and after so many years of working out the kinks, the basic structure is pretty much the same no matter where they’re domiciled.
General Small Business
S corporation taxation is the corporation’s answer to a pass-through tax status. Just like a corporation can elect S corporation tax status, so can a limited liability company that has elected corporation taxation.
You may think this move is a waste of time considering LLCs already have a pass-through tax status by default, but S corporation taxation differs from partnership taxation on some pretty big issues — namely, in what taxes you pay when you take money out of the company.
All S corporations start out as regular corporations. An S corporation is formed only when a regular corporation elects a special small-business tax status with the IRS. This is done by filing an S Election, Form 2553, with the IRS within a few months of the corporation’s formation.
Obtaining pass-through taxation, corporation style
S corporation tax status is a pass-through tax status.
If you’re planning on being the only member of your limited liability company (LLC), your LLC will be designated as a single-member LLC (SLLC). Several states’ courts have ruled that single-member LLCs don’t offer the dual-layer of liability protection, called charging order protection, that regular LLCs offer.
A sole proprietorship automatically exists whenever you engage in business by and for yourself, without partners and without the protection of an LLC, corporation, or limited partnership. Although it sounds fancy and complicated, forming a sole proprietorship is about as easy as it gets.
Forming a sole proprietorship
When you begin transacting business, be it selling crafts at the local art fair or doing web design work in your spare time, you become a sole proprietor.
Think the federal security laws are a hassle? Well, the ride ain’t over! Not only do you have to comply with federal laws, which are regulated by the SEC, but you also have to register your limited liability company (LLC) and follow state laws — often called blue sky laws — in every state where you’re prospectively looking for money.
General Small Business
More often than not, upstart capital for budding enterprises comes from the founders and people willing to finance it for a piece of the action (otherwise known as investors), which is why raising capital is a vital aspect of any up-and-coming business. Unlike sole proprietorships or general partnerships, limited liability companies (LLCs) can actually sell portions of the ownership, the membership shares.
General Small Business
LLCs, or limited liability companies, are one of the most flexible business entities. They allow you to choose how to distribute the profits, decide who manages the business's day-to-day affairs, and decide how the profits are to be taxed. They also offer a lot in terms of liability protection. The overall advantages of the LLC include the following:
Personal liability protection: Any creditors who come knocking or lawsuits filed against your business can't affect you personally.
If you’ve ever heard of a family limited partnership, then you may think that you have an idea of what a family limited liability company is all about. Ironically, there is no such legal entity as a family limited partnership or a family LLC.
If you were to call up your secretary of state and ask how to go about forming one, you’d hear a long pause at the end of the line.
General Small Business
All states have guidelines that dictate the management and ownership structure of a limited liability company (LLC), and they may seem a bit rigid. Unfortunately, if more people read their state statutes, they would realize how lax these statutes really are.
Although the default laws can be undesirable, the states allow the majority of them to be overridden by custom rules built into the company’s operating agreement, thus (again) making the LLC the most flexible entity around.
General Small Business
As you probably know by now, the legal term for the owners of a limited liability company (LLC) is members. The best way to understand the concept is to think of the ownership of the LLC as a big pie made up of membership units or membership interest. (Different states tend to use slightly different terms, but they all mean the same thing.
General Small Business
The low-profit limited liability company (L3C for short), the newest form of LLC, is a hybrid entity that sets out to bridge the gap between the for-profit and nonprofit business structures. L3Cs are a product of the social-consciousness movement and are still for-profit businesses, with the exception that profit motives take a backseat to the primary objective of public and social benefit.
Although limited liability companies (LLCs) are separate from their owners in a lot of ways, they still need to have them. An LLC without an owner is like a child without parents: It simply doesn’t exist.
So, even though you may have called up a filing company and filed your LLC with the state, until you go through the process of doling out ownership in your LLC, it doesn’t become its own legitimate entity.
General Small Business
In all states except California, licensed professionals are allowed to operate under an LLC. In some states, you can actually form a specific entity called a professional limited liability company (professional LLC or PLLC for short), and in other states, you just file a regular ol’ LLC and then abide by some best practices to make sure that you remain in compliance.
In certain states, a limited liability company can be comprised of numerous series (or cells), each with its own separate veil of liability protection. This is called a series LLC, and it’s often used as an asset protection device that, in some states, saves the formation fees and the hassle of creating multiple LLCs for each asset.
General Small Business
A single-member LLC isn’t actually a different type of LLC. It’s just a normal, regular LLC with one exception: there is only one member. Because LLCs were originally intended to be partnerships, a single-member LLC is still subject to some slightly different rules. Unlike an LLC with multiple members, a single member LLC is not allowed to elect the partnership form of taxation with the IRS.
General Small Business
If your limited liability company (LLC) elects a form of pass-through taxation — for example, partnership taxation, s-corporation taxation, or a single-member LLC electing disregarded taxation — then the LLC itself will not pay taxes.
For example, you and your partner are the members of Good Times, LLC.
You have a 20 percent membership interest and your partner has 80 percent.
Don’t know exactly what a formation company is? Sure you do! Have you seen those ads offering to form your LLC for a few hundred dollars? Normally, those ads are placed by formation companies — companies whose sole business is forming corporations and LLCs.
These companies seem to be popping up everywhere. With all the advertisements and hoopla, the real question is: Do you really need a formation company?
When a sole proprietor takes on one or more partners, a general partnership is born. Because a sole proprietorship by its very nature can be owned by only one person, there is no exception to this rule. Occasionally, smart entrepreneurs create a general partnership agreement among the partners.
Like a sole proprietorship, no other paperwork is completed, and no filings need to be made for the formation to take place.
General Small Business
A limited liability partnership is like a limited partnership without limited partners. An LLP has only general partners who are held personally responsible for the debts and obligations of the business. So how is this entity different from a general partnership, you ask?
Well, an LLP has an added layer of liability protection that insulates the partners from the wrongful acts of the other partners.
Think of a limited partnership as a general partnership with a little bit of protection against lawsuits thrown in. Whereas a general partnership doesn’t protect any of the owners against the business’s lawsuits and creditors, a limited partnership protects the silent partners of the business (also called the limited partners).
The Limited Liability Company (more commonly known by its acronym, LLC) is by far the most popular business structure. Only a decade ago, the LLC was the new kid on the block — untrusted and unverified. Luckily, that changed pretty rapidly — LLCs gained popularity and, within a short time, became firmly established in the business world.
Your operating agreement is the blueprint for your business and is the first thing you should get started on after you file your limited liability company's articles of organization. It lays out everything relating to your business, including how the ownership is structured, the rules regarding transferring the ownership, how your business is managed, how important issues are decided .
General Small Business
A limited liability limited partnership (try saying that ten times fast!) is sort of a hybrid between a limited partnership and a limited liability partnership. Like a limited partnership, an LLLP has both limited partners, who have limited liability and risk losing only whatever amount they invested in the business, and general partners, who are personally liable for the debts and obligations of the business.
Operating agreements generally don’t get into specific issues such as minor employment matters and day-to-day business operations (with the exception of major decisions and/or purchases). You don’t look at your operating agreement to see what sort of commission structure you should impose on your new sales reps.
General Small Business
States require a business to have what is called a registered agent — a term that is interchangeable with resident agent and statutory agent — in the state in which you domicile or “home” your limited liability company (LLC) and in every state in which you transact business.
A registered agent’s primary duties are to have an in-state address that is not a P.
Before you can file any formation paperwork for your LLC, you need to choose a registered agent (sometimes known as a resident agent or statutory agent or by its acronym RA). A registered agent is a person or company that’s always available during business hours, every single day, to accept formal legal documents for your company in the unfortunate instance that you are sued.
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