For anyone looking to get started in their business, forming an LLC is a great way to begin.  The LLC provides you the legal protection of a corporation with the flexibility of a sole-proprietorship. 

Setting up an LLC is fairly quick and can be done at very low costs.  Follow the steps below to learn how to form an LLC.

What's In This Article?

Common Questions for Starting an LLC

To get you started, here are some common questions asked about starting an LLC.

A Limited Liability Company (LLC), is a legal business entity similar to a sole-proprietorship or partnership except it provides legal limited liability protection for the business owners and their personal assets. With an LLC, the owner of a business is personally protected against all business debts and court judgments.

The main benefit is the corporate veil that is created providing the legal protection of a business owner’s personal assets (home, car, personal bank accounts, etc..) and limit on personal liability. There are also some legal and tax advantages that can be applied as well compared to a corporation or sole-proprietorship.

People typically form an LLC when their business faces a chance of potential risk suck as a lawsuit. If your business operates in a field that has a high chance of getting a lawsuit, it is recommended to form an LLC for legal protection.

LLC’s are commonly used for small businesses and in real estate investing.

Although it is not required to use an attorney to file an LLC, it is recommended to have one review through your operating agreement to confirm proper state compliance for your business as well as to assist in protecting your best interests.

Typical costs to file for an LLC can range from $40 – $500 if filing yourself and depending on state fees. Alternatively there are also third party services that can do this for you at similar costs with additional enhanced service options.

With a typical LLC, only two documents need to be filed:

  1. The Articles of Organization (Also known as the “Articles of Formation” or “Certificate of Formation” in some states)
  2. Operating Agreement – Although this is not always required for filing, it is highly recommended to have this created.

    Read more about the required LLC paperwork

No, an LLC does not issue stock. Unlike a corporation with shareholders, owners of the LLC are called members. Instead of stock, members have their percent interest in the company. This is typically defined within the Operating Agreement.

LLC’s have the option to be taxed as partnerships or corporations.

The typical partnership LLC is taxed based on 100% of its earnings as a pass-through taxation. All earnings are filed on the members taxes at the end of the year.

See more about LLC taxes and distributions below

Getting Started – Setting Up Your LLC

Step 1 – Decide Members (Owners)

To get started, first you will need to identify if you are going to form the LLC as a:

  • Partnership (multiple members); or
  • Sole-proprietorship (one member).

This is where you will decide how many members will be involved.  If only you will be forming the LLC, a sole-proprietorship will be elected. The minimum number of members to form an LLC is one.

Do not be worried if you wish to add or remove a member in the future as this is a fairly easy process.  Typically the rules to adding/removing a member will be outlined in your Operating Agreement.  Also there is no need to notify the state when a new member is added as it will show on their tax records at the end of the year.

Step 2 – Elect Management

Depending on if you are going in with a partnership or electing to run your business on your own, you will need to decide how the LLC is to be managed. The typical default used is Member-Managed, where the members of the LLC oversee the day-to-day operations.

An alternate option is Manager-Managed where a separate level of management is elected and one or more people are appointed to manage the LLC. This election is less common for starting LLCs.

Step 3 – Obtain Financing

When looking to finance your LLC, you can either obtain it through two ways:

  • Debt (taking a loan); or
  • equity (also known as capital contributions)

Overall these are called Assets and will be outlined in the Operating Agreement when forming the LLC. Typically the amount contributed will define the member’s percent interest (capital) invested in the LLC. Also if the LLC must be dissolved later in time, this capital interest will determine the portion of LLC assets each member is entitled to.

Debt (Taking a Loan)

Taking a loan from a bank, friends & family, or other means is taking on debt. Loans can be very useful to enhance the LLC’s cash reserves or cover additional expenses.

Money taken as debt is not accounted for as income but instead a liability because it must be paid back and typically includes interest. Because of this, neither the LLC or members will pay taxes on it.

Example: In a sole-proprietorship, a $10,000 loan is made when forming the LLC. The loan has a 5% interest rate and is made repayable in monthly installments over a 36 month period. Repayment to the loan will include interest no matter if the LLC is profitable or not.

The LLC deducts the interest payments as a business expense reducing the overall profits and later total taxes paid on those profits.

Equity (Capital Contributions)

Capital contributions consist of cash, property, or services that is invested into the business from the start. This includes contributions to be made today, or in the future.

Capital investments into an LLC are normally tax free. No members have to pay taxes on their percent interest received and the LLC does not pay taxes on the capital it obtains. All taxes are deferred until later when the business is sold or dissolved. At the time of sale, exit, or dissolution, the exiting member(s) will be taxed on any profits made allocated by their percent interest initially invested.

Example: In a sole-proprietorship, a $10,000 capital contribution is made when forming the LLC. The forming member receives 100% capital interest in the business. Later when the business is sold for $80,000, the forming member is only required to pay taxes on the $70,000 profit ($80k – $10k = 70k profit).

Step 4 – Compensation Elections

Let’s Get Paid!

Deciding how money comes out of the LLC is the fun part! With an LLC you can elect to get paid either of two options:

Option 1 - Salary

With a typical partnership tax election LLC, the business can pay a reasonable salary (known as a guaranteed payment) to the members. The salary will be taxed as ordinary income and the LLC will deduct the distribution as a business expense against profits earned (i.e. Net Income). The remaining net income will then be distributed to all members.

Example: Member A and Member B have 50% ownership interest in the LLC. Member A receives a salary of $30,000 annually and Member B receives a salary of $40,000 annually. During the year, the LLC earns $100,000. At year end, Member A and Member B’s salaries are deducted as business expenses ($70,000 total). The LLC has no other business expenses outside of both salaries paid. Total remaining profit (net income) is $30,000 ($100,000 – $70,000 = $30,000). With 50% ownership, the $30,000 in remaining profit is then split evenly and distributed to each member.

Option 2 - Profit Distribution

If a salary is not taken as a guaranteed payments, then net profits will be distributed to each respective member of the LLC (known as the members “Distributive Share”). Distribution of the net profits will be determined by the percent ownership interest of each member or as otherwise stated within the Operating Agreement.

With the above example, the total $100,000 net profit of the LLC will be distributed evenly (50/50) based on membership interest. Both members would receive $50,000 at year end.

Step 5 – Select a Name

This is the fun part where you get to pick a name for your LLC. The name will have to comply with state legal requirements and will require the designator “Limited Liability Company” or “Limited Company”. In most states the abbreviation LLC will also be accepted.

Here are some name variations below:
  • ABC Services Limited Liability Company
  • ABC Services Limited Company
  • ABC Services Limited Co.
  • ABC Services LLC (Most Common Use)
  • ABC Services L.L.C.
  • ABC Services L.C.
  • ABC Services LC
  • ABC Services Ltd. Co.
  • ABC Services Ltd. Liability Co.

Warning: Your name will be rejected if it is already in use or very similar to another registered LLC. In this case you will need to choose a different name. Prior to submitting your LLC name, you can lookup all registered LLC’s on your state’s Corporation and Business Entity database prior to filing.

Check For Potential Trademark Conflicts

If the name is approved, it may still have potential trademark conflicts that should be checked. For example using “Starbuck” or “McDarrels” would be trademark infringements. It is recommended you conduct a national search to confirm the name is not going to cause any legal trademark violations. You can go to https://www.uspto.gov/trademark to access more information on trademarks.

Note: You do not have to be locked into your business name forever. If you would like to use an alternate name in the future, you can register the new name as an “assumed” or “fictitious business name” with the state

Caution: Conducting a name availability check does not guarantee you the name. Not until the Articles of Organization for an LLC have been filed and accepted, the name is not yours. So wait on purchasing signs and business cards until all paperwork has been accepted.

Step 6 – File the Paperwork

It is now time to begin working on the paperwork for the LLC. Typically only two legal documents are created when forming the LLC known as the Articles of Organization (Also known as the “Articles of Formation” or “Certificate of Formation” in some states) and the Operation Agreement. These documents will be submitted when filing the LLC within your state.

The Articles of Organization is a simple document that contains the key details of your LLC and is used when filing for the LLC with your state. Typically the state you are filing the LLC in will provide you the Articles of Organization form which can be completed and submitted online.

The Operating Agreement sets the rules for how the owners (known as members) will run the business while also defining their rights and responsibilities associated. Its primary purpose is to uphold the limited liability that the LLC provides in order to prevent piercing the corporate veil.

Similar to a partnership agreement or corporate bylaws, the Operating Agreement structures the LLC covering items such as finances, ownership details, and management responsibilities. Not all states require an operating agreement to form an LLC but it is highly recommended one is created in order to uphold the limited liability of the LLC.

Typically operating agreements are used with multi-member LLC’s due to their nature of outlining percent interest and roles. This can be seen with both member-managed and manager-managed LLC’s. While an Operating Agreement is necessary for multi-member LLC’s, it is also essential for sustaining the validity and protection of single member LLC’s as well.

Step 7 – Submit & File the LLC

Now all steps above and paperwork is completed, you may submit the LLC application with your state for acceptance.

Congratulations
on your LLC!

After the LLC is Formed

Once all documents have been submitted and accepted by your state, you will have some additional items to are either legally required to set up such as a business bank account, EIN number, make any publication notifications, and wrap up any unsettled finances. Review with your state guidelines that are necessary to complete the LLC.

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