Fact checked for accuracy by Janet Berry-Johnson, CPA.
If you’re thinking of starting a business, then the first question you need to ask yourself is, “What type of business structure do I need?” Your business structure will be the base for everything from your business model to how you operate as a legal entity.
There are many types of business structures, and picking the suitable model for your business to follow can be a challenging task. One of the most common business structures is an LLC. There are 21.6 million in the United States alone. But what exactly is an LLC? How do you start one?
What Is an LLC?
LLC stands for limited liability company. This is a label that people can apply for when they start a business and stand in the middle of a corporation and a privately owned business (partnership or sole proprietorship).
The reason it exists in the middle is that it has factors or attributes of both. LLC’s can choose between the tax laws, or they can be treated as a partnership. In this way, they’re very flexible and can also be treated as non-profits.
The primary characteristic that LLCs share with corporations is their limited liability. If you own a partnership or sole proprietorship, you are solely responsible for anything done at your company. With an LLC or corporation, that responsibility falls on the company as opposed to the individual.
There are two types of LLCs that you can form: single-member LLCs and multi-member LLCs. Read our guides linked here to learn more about the advantages and disadvantages of each.
How to Start an LLC
LLCs need to be officially formed and registered. They can do so by filing their “articles of organization” and being recognized by the state or country in which they’re organized. You begin by selecting the state where you want to start and then naming your LLC.
Next, you’ll find an agent or business that is already registered to send and receive legal documents for your company. After that, you’ll file with the state and choose your management structure.
LLCs can either be member-managed or manager-managed. This determines whether you and your partners manage the company or a separate individual you entrust with executive powers. Then you’ll move on to your LLC operating agreement.
The agreement will contain various structural decisions for the company, including its organization, decision-making system, financial support, distribution of profits, and how the LLC dissolves if it comes to that. Afterward, you’ll get an EIN.
An EIN is an employer identification number and allows others to recognize your business as an official employer. Afterward, you can look into filing for your company to do business in other states. Keep in mind that EIN isn’t just for LLCs with employees. It’s also used as an identification number, similar to a Social Security number, for filing tax returns, making tax payments, and opening a business bank account.
For more, read our entire article on how to start an LLC.
Benefits of Forming an LLC
LLCs are popular because they have many benefits and advantages over other business structures.
As we mentioned earlier, with an LLC, individuals can’t be held legally accountable, only the business itself. This same logic applies to debts. If you are the only owner of a sole proprietorship, then all of the business’s debts fall onto you.
With an LLC, the company’s finances remain independent. That means banks can’t demand repayment or repossess your car if your business starts failing.
All the positives of a corporation without so many headaches
To become a corporation, the process is a lot longer and more involved. It has many benefits like less liability and better tax laws, but the process of forming one is long, expensive, and will often require professional legal help.
After a corporation is formed, they have many obligations, reports, and fees mandatory in most states.
Choosing the tax system you like best
Once you form an LLC, you’ll be able to make your choice of taxation status. LLCs with only one member can be taxed as a sole proprietorship, S or C corporation, or a partnership. LLCs with more than one member can be taxed as an S or C corporation, or a partnership.
This choice gives you a lot more flexibility with your company’s taxes. Try to choose the standard system in your industry that best correlates with your company’s income.
For all tax structures except for C corporations, the LLC is treated as a pass-through business. This means you bypass corporate income taxation and report the LLC’s revenue and costs on the owner’s tax returns. This would also mean owners are responsible for any profits on their personal income tax.
For more on this subject, read our guide on LLC taxes.
One of the most significant benefits of forming a corporation is having shareholders. People can buy shares of the company, increasing investment funds and pushing the company forward.
The problem is S corporations can only have 100 shareholders while LLC has no limit on their shareholders. Again, LLCs get the benefits of being a corporation without any of the restrictions.
You can distribute the profits how you choose
With partnerships, companies distribute profit shares based on the percentage of the company that a person owns. With an LLC, you can distribute the profits how you choose.
Even if someone owns more of the company, you can agree that you will take a larger share of the profits.
Is an LLC the Best Business Structure?
For most people, an LLC is the best business structure. It has the best of both worlds between corporations and other structures and provides owners with the most flexibility. If you plan on investing in your own business and already have the funding, then an LLC is the right choice.
LLCs are also straightforward to maintain compared to other structures. Mostly you just pay taxes and get registered, and after that, it is smooth sailing. Once you set it up, it doesn’t require much maintenance or legal action, and you can focus on running a successful business.
Who an LLC Might Not Be a Good Fit For
People looking for wealthy investors into their business might not be the best fit for an LLC. LLCs are formed and guided by their founders, and that lack of control might scare away investors who want their fair share of the company and its profits.
To attract wealthy investors, it’s best to start a partnership or a corporation where profits are equally divided based on the percentage of the company you own.
Also, if you’re a sole proprietorship without a ton of growth plans or personal liability, keeping your business that way could be just fine. For more on that decision, read our guide on when is the best time to form an LLC?
Best States to Form an LLC
The way to find a good state for starting an LLC is by checking on tax rates. You want to find states with relatively low corporate and income tax rates so you can maximize profits.
Wyoming has a corporate and individual income tax rate of 0%. This low percentage means that the only taxes you’ll have to worry about are federal. They also have a meager property tax rate of 0.61%, almost half the national average.
Again, South Dakota ranks high on the list of states for starting an LLC because they have a 0% corporate and individual income tax rate. They are slightly less appealing than Wyoming because their property tax rate is 1.19%.
However, they have a lower unemployment rate, which benefits your company’s chances of finding high-quality workers in-state.
If you’re looking for somewhere warmer to start your LLC, then try Nevada. Beyond the occasional trip to Vegas, you’ll also enjoy a 0% Corporate and individual income tax rate. Their property tax is slightly lower than South Dakota’s at 0.77%.
Keep in mind that Nevada does levy a gross receipts tax, known as a Commerce Tax, on any business with gross receipts over $4 million, so they are a little less business-friendly than they used to be.
While it has a corporate tax rate of 5.5%, the 0% personal income tax still makes Florida very appealing for starting an LLC. Using a tax system directly through the owner will allow you to avoid the corporate tax entirely.
How Much Does It Cost to Form an LLC?
The cost of starting an LLC depends heavily on the state where you form it. Filing fees can range from $40 to $500, with the average at $132. The lowest fees are in Arkansas, Hawaii, Iowa, Oklahoma, and Mississippi. The highest fee is in Massachusetts.
You’ll also have to consider several other fees for forming an LLC. For example, will you file yourself, or will you have a lawyer/LLC formation service do it for you? You’ll also need to purchase an operating agreement online, which can range from $50 to $200.
Finally, you’ll have to pay any annual fees that your state requires, which can cost up to $800. The cheapest way to form an LLC is to do everything yourself.
Should You Use an LLC Formation Service?
LLC formation services are a great way to make sure you keep your business compliant and organized without taking up a ton of your time on admin tasks. What you need to watch out for is hidden fees and annual charges that can become very expensive over time.
While some incorporation websites might appear cheap, you need to read the agreement carefully. Without your knowledge, you could be signing yourself up for several extra fees in the long run. However, there are a lot of good options out there that have transparent pricing and services, like ZenBusiness and IncFile, which we recommend for most small business owners.
More Information on LLCs
- LLC vs. corporation
- LLC vs. sole proprietorship
- LLC vs. partnership
- LLC vs. DBA
- LLC vs. PLLC
- How to form an anonymous LLC
- What is a domestic LLC?
- How do I pay myself from an LLC?
- I just formed my LLC – now what?
- How to add members to your LLC
- Can you sue a dissolved LLC?
- How to name an LLC
- Does my LLC need a certificate of good standing?
- How to form a series LLC
- How to form a professional LLC
The Last Word
LLCs are a fantastic way to start and grow your business. Just remember to do your research on the entity setup that is going to be best for you and your business in the long run. Best of luck to you and please let us know if you have any questions.
Filed under: Advice Columns