As an entrepreneur, it is indispensable to set clear & high goals at the outset of the career to avoid any failures. To form an LLC business is one of the excellent decisions that any entrepreneur could ever take to strengthen the foundation of a business. It is like forming a hybrid business structure that blends well with the flexibility, simplicity, and most importantly, the tax advantages of a partnership along with the corporation’s liability protection.
Let us have a closer look at the basic concept of forming a limited liability company and at the reasons why it has become the best business entity choice, throughout the post.
What is an LLC?
LLC or Limited Liability Company is usually defined by its most alluring benefit of allowing business owners to keep their personal and business assets separate. Therefore, if any entrepreneur forms an LLC, they could successfully limit their liabilities, especially concerning the business debts & responsibilities.
Today, an LLC business has come up as one of the most accepted & popular business structures for small & new business. It is because of the reason that to form an LLC is more flexible & more straightforward than a corporation. Even in the US, the LLC company is considered as the type of business entity that combines the pass-through taxation of a sole proprietorship or a partnership with the corporation’s limited liability. It has, thus, created a very considerable world for business owners. In short, if you form an LLC, your business would become a distinct and separate legal entity, with distinguished debts and legal matters.
Why should I form an LLC?
Whether you are already operating as a partnership, a sole proprietor, or merely about to start a business, you might encounter this question
Well, numerous considerations come into play while choosing the form of your business. It includes crucial factors like personal liability, the total cost required for the formation & registration of your business, and the tax obligations. And the reasons why you should choose to form an LLC over other types of corporations include – To limit your personal liabilities for the company’s debt, numerous tax advantages, to raise capital from potential investors.
To limit your personal liabilities for the company’s debt
If you form an LLC, only those assets will be subjected to the claims of business creditors, that are owned in the name of the LLC. It also includes all the lawsuits against the business. It gives a huge sigh of relief since, to satisfy business debts, one cannot claim the personal assets of the LLC members.
To raise capital from the potential investors
If you want to raise more funds/capital, to form an LLC would be the best option. You can bring in those members who are willing to contribute to the growth of your business. They can provide their properties, funds, or other critical services.
Numerous tax advantages
Unlike a corporation, you do not require a separate tax that is to be levied on the LLC itself. Moreover, the loses & profits of an LLC company are commonly passed on to the members similar to the “partnership.”
To understand more about the tax benefits of an LLC business, you can compare the state’s fees associated with both corporations & LLC. By comparative analysis, you can decide on the fact, which option is more affordable to form and easy to maintain.
If you are still confused with the fact that why should you consider an LLC business, we have shared three critical questions below for a self-analysis. Let’s have a closer look at it:
- Have you successfully found your first paying customer?
- Do you want to prevent your personal assets from putting it at risk?
- Do you have multiple business partners or owners in the business?
What an LLC actually protects and doesn’t protect?
To form an LLC means that, by law, your business would be a separate entity. It merely means that you can also perform the necessary tasks like –
- Opening & maintaining dedicated bank accounts.
- You can own a property.
- You can sue a company and also be sued.
The most important thing to be noticed here is that if someone is feeling litigious, they would attempt to sue your LLC business, but not you.
As an example, let us say that you have written a statement in your blog against a company or a person highlighting any fraudulent activity. In that case, if the mentioned party could come after you to claim for defamation. Furthermore, if they pursue any legal action, your personal assets are protected, being an LLC business, including – your home, car, investment accounts. However, the assets you have invested in your business are always at risk.
Also, if you form an LLC, you will not even be responsible/ liable for the things, your employees or business partners might do recklessly. However, asset protection could not be called as the complete safeguard, in case of any wrongdoing. In fact, before any bad thing happens, you need to put many aspects in place. Here are the points, you could be liable for, even if you have an LLC business.
- If you have borrowed a loan from the bank under your personal name, instead of your business – you are still liable.
- You will be liable if you’ve injured someone on/with the property, which is personally owned by you.
- Another essential aspect that you need to consider is the taxes you withhold from employee wages. If you try to become shady or do illegal things, you would definitely be liable for your deeds.
In a nutshell, we can say that forming an LLC business is like adding an additional layer of protection. However, you still require the advice from an expert/ lawyer for clarifying numerous vital aspects of an LLC.
Understanding LLC Requirements
Unlike corporations, if you form an LLC, you do not require holding up annual meetings. Moreover, you are even not subjected to stringent record keeping. But, you have to separate from your personal finances from those of the business expenses. Here is the list of the most common LLC requirements you’ll need to keep in mind.
Limited Liabilities Companies Operating Agreements
An operating agreement is the governing document of an LLC. In this agreement, the members layout all essential provisions including – ownership parameters, and the standards for LLC governance. Also, the rules around member changes like removing & adding members in case of incapacity or sudden demise of any existing member. This agreement is not recorded with the state, instead is an internal agreement amongst the owners & members.
Limited Liabilities Companies Annual Reports
There are various state-specific rules for forming an LLC. And according to many states, you need to file a biennial/annual report with SOS or the Secretary of State. Let us say, if you fail to report these annual reports, your business may get dissolved. To know about the specific requirements for your state, you can refer to a reliable LLC state guide.
How are LLCs taxed?
Before you dive in deep into the concept of state-specific tax laws, let us understand – the basics of how LLCs are taxed.
Operating a Limited Liability Company (LLC) means you have a “pass-through entity,” as per IRS. It represents that all the LLCs losses and profits would “pass-through” the business to the LLC owners/members. Further, they have to report this information on their tax returns(personal). And when it comes to the federal income taxes, an LLC business does not pay it. However, few states do charge the LLC itself a tax (we have already mentioned that the rules vary according to the states).
The internal revenue service treats the LLC business as a partnership or sole proprietorship based on the total number of LLC members. If you are already doing business(whether as a partnership or a sole proprietorship), you might be aware of some of the critical rules.
Let us have a closer look at some of the basics:
The one-member LLCs are treated as sole proprietorships for tax purposes by the IRS. It simply means an LLC itself does not need to file a return with the IRS or pay taxes. You have to report all LLC profits & losses on Schedule C, and this report is to be submitted with 1040 tax return. In case you decide to leave the profits in the LLC business bank account to cover future expenses, you have to pay taxes on that money (at the year-end).
If you form an LLC with multiple owners/members, the IRS will treat your LLCs as partnerships for tax purposes. Co-owned LLCs merely means that as a co-member, you do not need to pay taxes on your LLCs business income. In fact, as an LLC co-owner/owner, you would only pay taxes on the dedicated lawful share of the profits. These profits are calculated on their personal income tax returns that are attached with Schedule E.
Later, this distributive share is set out in the LLC operating agreement (each LLC owners share of profits and losses). And most of the operating agreements consider the owner’s distributive share as in proportion to the percentage of interest in the LLC business.
To be precise, let us say if Tim owns 70% of the LLC, and Laila owns the other remaining 30%. In this case, Tim will be entitled to 70% of the LLC’s losses & profits, and 30% will be entitled to Laila. If you decide to split up the losses & profits, not in proportion to the percentage of interest in the LLC business, it would be termed as special allocation. Remember, you need to follow the IRS rules carefully.
However, if the owner’s distributive shares are divvied up, IRS would be treating each of LLC owner/member as if they are going to receive the dedicated distributive share each year. To make it understandable, let’s say that if you are one of the LLC members, you have to pay taxes on your dedicated distributive share. Even though, LLC is not distributing you the money to you ( for that share).
Although co-owned LLC is not required to pay income taxes, you have to file Form 1065 with the IRS. It is similar to the one that a partnership files. It is basically an informational return that is reviewed by the IRS for making sure that each LLC member/owner is reporting their income genuinely.
The LLC business should also provide each LLC owner with a “Schedule K-1.” It breaks down the share of profits & losses of LLCs business (each member’s share individually). In return, each LLC owner reports the required & essential information on the individual Form 1040 with attached Schedule E.
Limited Liability Companies Can Elect Corporate Taxation
As an LLC business owner, do you require to retain a notable amount of profits in the company? If yes, you or other LLC members(co-owners) could save money by electing to have your LLC business taxed as a corporation.
Estimating & Paying Income Taxes
As you know that the LLC members are never categorized as employees of the LLC, they have not subjected to the withholding taxes. In fact, LLC business members are considered as self-employed business owners, who are responsible for setting aside sufficient money to pay taxes in the name of the share of the profits. All you need to do is to estimate the total amount of tax that you could owe for around one year and further pay it to the IRS. The decided window of the payment is every quarter – January, April, June, and September.
For a similar reason, which we have already mentioned, if you form an LLC, you become self-employed business owners. And all your contributions to the Medicare system and the Social Security ( i.e., self-employment tax) are not withheld from paychecks. In fact, as an LLC business owner, you need to pay this self-employment tax directly to the IRS.
According to the current rule, any LLC business owner/ member who is managing the business has to pay for the intended distributive/rightful share of profits. If any of the members are inactive or not contributing to maintaining your LLC business/ taking management decisions may be exempted from paying self-employment taxes.
The rules & regulations in this era are a bit complicated. Besides, if you somehow manage to work consistently in your LLC business, you are undoubtedly expected to pay the self-employment tax on all LLC profits. Each owner or LLC member is subjected to the self-employment tax has to report it on Schedule SE. It is mandatory to submit it with 1040 tax return.
Infact, LLC owners/members have to pay twice the self-employment tax as regular employees. And the contribution of the self-employment tax is matched by their employers.
A report on Self-Employment Tax in 2019 by TheStreet, Inc. which is an American financial news and services website has clarified statistical facts about it. It posted – according to the Internal Revenue Service (IRS), the self-employment tax rate of the year 2019 is 2.9% for Medicare or on the net earnings for Medicaid tax. And around12.4% for Social Security on the first $128,400 of net income. Thus, the combined tax for the year 2018 is 15.3%.
Expenses & Deductions
As we know, you do not require to pay income tax or self-employment taxes on the amount, which your LLC business is going to spend in pursuit of profit. So, you cannot “write off” or deduct your legitimate LLC business expenses from your business income. It can further lower your profits, which you have to report to the IRS. These deductible expenses usually include automobile, entertainment & business travel packages, promotion & advertising cost, and overall start-up costs.
State Taxes & Fees
Most of the states imply the tax on LLC profits the same way the IRS does. If you are an LLC business owner, you would have to pay taxes on your personal returns to the state. And we already know, the LLC itself does not pay a state tax. Moreover, there are a few states that charge the tax on LLC business based on the total earning it makes along with the income tax paid by the LLC owners.
To be more precise, let us understand this concept with an example. California imposes a tax on LLC business that makes over $250,000 per year and the tax levied on this slab ranges from about $1,000 to $9,000. Moreover, a few states like Delaware, California, Massachusetts, Illinois, Pennsylvania, New Hampshire, and Wyoming charges an annual fee on LLC business. This tax is also termed as a” franchise tax” or a “renewal fee,” and sometimes as an “annual registration fee.”
The approximate fee you need to pay as this franchise tax is about $100. However, California imposes a hefty $800 charge per/year from LLC business. If you decide to form an LLC business in Massachusetts, Illinois, and Pennsylvania, then you will be charged $500, $300, and $330, respectively.
Therefore, before you form an LLC, you should figure out if your state imposes a separate LLC-level tax. To gather this information, you may visit the State’s Revenue or Tax Department’s official website. Or you may give them a call as per your own convenience.
How do I Form an LLC?
Various steps are required to create an LLC business. Here is a brief checklist that you need to keep in mind while applying for an LLC formation.
Step 1: Choose an appropriate business name
As a first step, you have a register a unique name in the state where you desire to set up your business. Remember to follow the guidelines like – checking for the name availability to ensure its uniqueness, before filing articles of organization. You could search county clerks’ offices, online directories, and the secretary of state’s website in your state.
Step 2: Choose a registered agent
Second step is to appoint a registered agent, who could receive all official correspondence for your LLC business. Figure out this expert before filing articles of the organization since various states ask to list the dedicated registered agent’s name & address on the form. Opting for a third party to perform registered-agent services is preferable over electing the people within the company.
Step 3: File articles of organization
It is another crucial step that brings your LLC business into existence. Most of the states also demand necessary information or detail about your business. Along with the business plan and structure details, you need to provide – name, location, and management type.
Step 4: Get an employer identification number
As per the IRS, if there are multiple employees or members, or is operating as a partnership or a corporation, then you have to apply for an EIN. This nine-digit EIN is assigned to the businesses for tax purposes. This step is important if you form an LLC since according to the state laws, LLCs are classified for federal tax purposes.
Step 5: Draw up an operating agreement
It includes the information regarding your business’s management structure like – member voting rights, ownership breakdown, duties of members & managers, and the profits and loss distribution. It depends upon the state-specific rules that whether you would require an oral agreement or a written one.
Step 6: Establish a business checking account
This step is proven to be the most beneficial one concerning the credibility of your business. Opening a different LLC business bank account would help you to manage your personal and business-related expenses separately. It helps you to mitigate the potential risks to all your personal assets in case of any lawsuit calls ( if someone tries to sue your company).
Can I convert my existing business to an LLC?
It is the most exciting question that strikes the mind of those who want to convert their existing business ( sole proprietorship or a partnership) into an LLC business. And the very fortunate answer to this question is – a Yes! It is, in fact, the easiest way to protect the personal assets of a business without affecting the ways your business income or earning is being taxed.
Few states provide simple forms or “certificate of conversion” for converting a partnership into an LLC business. Partners and Sole proprietors that do not offer this form should file regular articles of organization for creating an LLC.
In some states, you need to publish a notice in a local newspaper regarding the termination of a partnership. It is to be accomplished before a partnership could be officially converted to an LLC. And the other common rule( for every state), you would require to transfer all identification numbers, permits & licenses in the name of your LLC business. The list includes:
- State EIN (employer identification number)
- FEIN(Federal employer identification number
- Business Permit (or tax registration)
- Sales Tax permit
- And Other Professional Permits.
How IncParadise helps you?
From the above post, you might have got some clear insight into the basic concept of forming an LLC along with its potential benefits. However, since the help of a professional is needed to avoid any legal obligations, IncParadise has come up as the most refined helping hand.
The team at IncParadise have all the expertise, which is required for the registration & incorporation process of your new business. Not only this, but we can also help you to convert your existing business to an LLC.
“If you also envision to put a strong foundation for the growth of your business – form an LLC”. To get an expert help and advise, Contact Us Right Away!