What is a Limited Liability Company?
A
limited liability company, commonly called an "LLC," is a business
structure that fits somewhere between the partnership or sole
proprietorship and the corporation. Like owners of partnerships or sole
proprietorships, LLC owners report business profits or losses on their
personal income tax returns; the LLC itself is not a separate taxable
entity.
Like a corporation, however, all LLC owners are protected from
personal liability for business debts and claims -- a feature known as "limited liability." This means that if the business owes money or
faces a lawsuit for some other reason, only the assets of the business
itself are at risk. Creditors normally can't reach the personal assets
of the LLC owners, such as a house or car. (Both LLC owners and
corporate shareholders can lose this protection by acting illegally,
unethically, or irresponsibly.)
For these reasons, many people say the LLC combines the best
features of both the partnership and corporate business structures.
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What is the Structure of an
LLC?
An LLC is owned by its members. The members of an LLC are like
partners in a partnership or shareholders of a corporation. A member
will more closely resemble a shareholder if the LLC utilizes a
manager or managers, because under that situation the members will
not participate in the management of the LLC. However, if the LLC
does not utilize managers, then the members will more closely
resemble partners because they will have decision making powers in
the LLC.
The member’s ownership in the LLC is represented by their
respective "membership interest", in the same manner as a partner
has an "interest" in a partnership or a shareholder has stock in
corporation.
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What are the Advantages of an LLC?
Pass-Through Taxation LLC’s allow for pass-through taxation,
allowing earnings of an LLC to be taxed only once. The earnings from
an LLC are treated in a similar manner as earnings from a
partnership, sole proprietorship and most S corporation.
Limited Liability:
The member’s liability is generally limited
to the amount of
money which the member invested in the LLC. As
a result, the
members of an LLC receive the same limited
liability
protection as do shareholders of a corporation.
Flexible Organizational Structure LLC’s are generally free to
establish any organizational structure agreed upon by its members.
Thus, profit interests may be separated from voting
interests.
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What are the Disadvantages of an LLC?
The possibility of losing pass-through taxation if the LLC is not
properly structured.
More paperwork and documentation is needed than in an ordinary
partnership.
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How many people do I need to form an LLC?
You can be the sole owner of your LLC (limited liability company) in all states.
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Who should form an LLC?
You
should consider forming an LLC (limited liability company) if you are
concerned about personal exposure to lawsuits arising from your
business. For example, if you decide to open a store-front business
that deals directly with the public, you may worry that your commercial
liability insurance won't fully protect your personal assets from
potential slip-and-fall lawsuits or claims by your suppliers for unpaid
bills. Running your business as an LLC may help you sleep better,
because it instantly gives you personal protection against these and
other potential claims against your business.
Not all businesses can operate as LLCs, however. Businesses in the
banking, trust, and insurance industry, for example, are typically
prohibited from forming LLCs. In addition, some states, including
California, prohibit professionals such as architects, accountants,
doctors, and licensed healthcare workers from forming LLCs.
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How do I form an LLC?
In
most states, the only legal requirement is that you file "articles of
organization" with your state's LLC filing office, which is usually
part of the secretary of state's office. (A few states refer to this
organizational document as a "certificate of organization" or a
"certificate of formation.") Most states provide a fill-in-the-blank
form that takes just a few minutes to prepare. You can obtain the form
by mail or download it from your state's website (check your state's
secretary of state or corporations division home page).
A few states require an additional step: Prior to filing your
articles of organization, you must publish your intention to form an
LLC in a local newspaper.
You'll also want to prepare an LLC operating agreement, though it
isn't legally required in most states. Your operating agreement
explicitly states the rights and responsibilities of the LLC owners.
The main reasons to do this are to clarify your business arrangements,
and to vary from the requirements of your state's LLC laws. If you
don't create a written operating agreement, the LLC laws of your state
will govern your LLC.
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Do I need a lawyer to form an LLC?
No.
All states allow business owners to form their own LLC by filing
articles of organization. In most states, the information required for
the articles of organization is non-technical -- it typically includes
the name of the LLC, the location of its principal office, the names
and addresses of the LLC's owners, and the name and address of the
LLC's registered agent (a person or company that agrees to accept legal
papers on behalf of the LLC).
Now that most states provide downloadable fill-in-the-blank forms
and instructions, the process is even easier. And LLC filing offices
are becoming more accustomed to dealing directly with business owners;
they often allow business owners to email questions to them directly.
Of course, if you're trying to decide whether the LLC is the right
structure for your business, you may want to consult an expert. You may
also want an expert to review your operating agreement or set up your
bookkeeping and accounting systems.
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Does my LLC need an operating agreement?
Although
most states' LLC laws don't require a written operating agreement, you
shouldn't consider starting business without one. Here's why an
operating agreement is necessary:
- It helps to ensure that courts will respect your personal liability
protection by showing that you have been conscientious about organizing
your LLC.
- It sets out rules that govern how profits will be split up, how
major business decisions will be made, and the procedures for handling
the departure and addition of members.
- It helps to avert misunderstandings between the owners over finances and management.
- It keeps your LLC from being governed by the default rules in your state's LLC laws, which might not be to your benefit.
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How are LLCs taxed?
Like
sole proprietorships (one-owner businesses) and partnerships, an LLC is
not considered a separate entity from its owners for tax purposes. This
means that the LLC does not generally pay any income taxes itself;
instead, the LLC owners pay taxes on their allocated share of profits
(or deduct their share of business losses) on their personal tax
returns.
LLC owners can elect to have their LLC taxed like a corporation.
This may reduce taxes for LLC owners who will regularly need to retain
a significant amount of profits in the company.
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What are the differences between a limited liability company and a partnership?
The
main difference between an LLC and a partnership is that LLC owners are
not personally liable for the company's debts and liabilities. This
means that creditors of the LLC usually cannot go after the owners'
personal assets to pay off LLC debts. Partners, on the other hand, do
not receive this limited liability protection unless they are
designated "limited" partners in their partnership agreement.
Also, owners of limited liability companies must file formal
articles of organization with their state's LLC filing office, pay a
filing fee, and comply with certain other state filing requirements
before they open for business. By contrast, people who form a
partnership don't need to file any formal paperwork and don't have to
pay any special fees.
LLCs and partnerships are almost identical when it comes to
taxation, however. In both types of businesses, the owners report
business income or losses on their personal tax returns; the business
itself does not pay tax on this money. In fact, LLC and partnerships
file the same informational tax return with the IRS (Form 1065) and
distribute the same schedules to the business's owners (Schedule K-1,
which lists each owner's share of income).
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Can I convert my existing business to an LLC?
Yes.
Converting a sole proprietorship or a partnership to an LLC is an easy
way for sole proprietors and partners to protect their personal assets
without changing the way their business income is taxed.
Some states provide a simple form for converting a partnership to an
LLC (often called a "certificate of conversion"). Sole proprietors and
partners in states that don't provide a conversion form must file
regular articles of organization to create an LLC.
In some states, before a partnership can officially convert to an
LLC, it must publish a notice in a local newspaper that the partnership
is being terminated. And in all states, you'll have to transfer all
identification numbers, licenses, and permits to the name of your new
LLC, including:
- your federal employer identification number
- your state employer identification number
- your sales tax permit
- your business license (or tax registration), and
- any professional licenses or permits.
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Do I need to know about securities laws to set up an LLC?
If
you'll be the sole owner of your LLC and you don't plan to take
investments from outsiders, your ownership interest in the LLC will not
be considered a "security" and you don't have to concern yourself with
these laws. For co-owned LLCs, however, the answer to this question is
not so clear.
First, let's consider the definition of a "security." A security is
an investment in a profit-making enterprise that is not run by the
investor. Here's another way to think about it: If a person invests in
a business with the expectation of making money from the efforts of others,
that person's investment is generally considered a "security" under
federal and state law. Conversely, when a person will rely on his or
her own efforts to make a profit (that is, he or she will be an active
owner of an LLC), that person's ownership interest in the company will
not usually be treated as a security.
How does this apply to you? Generally, if all of the owners will
actively manage the LLC -- the situation for most small start-up LLCs
-- the LLC ownership interests will not be considered securities. But
if one or more of your co-owners will not work for the company or play
an active role in managing the company -- as may be true for LLCs that
accept investments from friends and family or that are run by a special
management group -- your LLC's ownership interests may be treated as
securities by your state and by the federal Securities and Exchange
Commission (SEC).
If your ownership interests are considered securities, you must get
an exemption from the state and federal securities laws before the
initial owners of your LLC invest their money. If you don't qualify for
an exemption to the securities laws, you must register the sale of your
LLC's ownership interests with the SEC and your state.
Fortunately, smaller LLCs, even those that plan to sell memberships
to passive investors, usually qualify for securities law exemptions.
For example, SEC rules exempt the private sale of securities if all
owners reside in one state and all sales are made within the state;
this is called the "intrastate offering" exemption. Another federal
exemption covers "private offerings." A private offering is an
unadvertised sale that is limited to a small number of people (35 or
fewer) or to those who, because of their net worth or income earning
capacity, can reasonably be expected to be able to take care of
themselves in the investment process. Most states have enacted their
own versions of these popular federal exemptions.
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How is an LLC Managed?
An LLC is managed by its members or by selected managers.
If the LLC is managed by its members, it operates much like a
partnership. Each member shares equally in the decision making
process of the LLC.
Alternatively, the members may choose to appoint a manager or
managers to act in a capacity similar to a corporation’s board of
directors. The managers are in charge of the business affairs of the
LLC.
If managers are not designated in the articles of organization,
the members will be deemed to direct the business affairs of the
LLC.
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What is a Registered Agent and is one
needed?
In all states, an individual or service company must be
responsible for receiving important legal and tax documents. This
service is provided by an "agent" of the LLC who is "registered"
with the state of incorporation. Thus, the term "Registered Agent."
The registered agent must have a valid street address within the
state of formation, and be available during normal business hours to
receive documents.
The services performed by a registered agent may include:
Receiving and forwarding legal documents.
Receiving and
forwarding tax and report forms.
Accepting and forwarding service
of process.
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Should I choose an LLC or an S
Corporation?
The status of an S Corporation provides the elimination of double
taxation. However, the S Corporation does not have the flexibility
of an LLC in regard to the allocation of income to its members.
An LLC may have an unlimited number of members. However,
ownership in an S Corporation is limited to no more than 75
shareholders. Further, an S Corporation cannot have shareholders who
are C Corporations, other S Corporations, certain trusts, LLC’s,
partnerships or nonresident aliens.
LLC’s are permitted to own subsidiaries without restriction,
while S Corporations are not allowed to own 80% or more of another
corporation’s shares.
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How can I structure an LLC to achieve
pass-through taxation?
If an LLC wants to take advantage of pass-through taxation, it
must meet certain requirements which have been established. To have
pass-through taxation an LLC may not have more than two of the
following characteristics of a corporation:
Limited
Liability
Unlimited Life
Free Transferability of
Interest
Centralized Management
The LLC will have limited
liability, and if the LLC is managed by managers, the LLC will have
centralized management.
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What is an LLC Kit?
Once an LLC has been legally formed and is ready to complete its
organization, it will require an "LLC Kit" to complete its Operating
Agreement, maintain certain of its required records, and to
facilitate distribution of membership certificates.
The LLC Kit will include:
LLC Seal
Operating Agreement
Membership
Certificates
Book/Binder
Miscellaneous Forms
A LLC Seal is
a small press into which a document is placed to be embossed. The
imprint made by the seal indicates the LLC’s name, state of
formation and date of formation. An impression made by an LLC seal
helps to conveys the mark of authority upon business documents.
A Membership Certificate is a printed document used to indicate
ownership interest in an LLC. The LLC Kit supplied by CCFS
contains custom-printed membership certificates which may be issued
at the discretion of the LLC.
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What is a Federal Employer Identification
Number?
Once the LLC has been formed and is ready to do business, it is
the time to apply for a federal employer identification number
(EIN). Generally, any LLC doing business within the U.S. is required
to have an EIN. In fact, the EIN is necessary when filing tax
returns and for establishing bank accounts.
A LLC can receive an EIN by completing and submitting IRS Form
SS-4. However, you can have CCFS save you this tedious and
time consuming paperwork by completing and submitting the necessary
EIN form on your behalf.
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How do I begin the process of forming an
LLC for my business?
Once you have decided the type of business entity which is best
for your business, articles of organization must be filed with the
proper state agency together with certain fees.
CCFS will provide all necessary services to ensure that
the administrative processes are completed in the shortest period of
time, with the highest degree of skill and efficiency, and at the
lowest cost.
After the articles of organization are filed and accepted by the
designated state, your LLC must hold an organizational meeting and
adopt a proper Operating Agreement. The necessary Operating
Agreement recording material, LLC seal and membership certificates
are all included in CCFS LLC Kit.
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