Your Guide To
Starting an LLC Basics

Starting an LLC (limited liability company) is a process similar to starting a corporation. (Please see the discussion on Business Incorporation for additional information.) This information will be useful to you if you currently have, or are starting, a new small business or are reorganizing an existing one as a limited liability company (LLC).

Our purpose here is not to cover in depth all conceivable possibilities, angles or nuances of the LLC form – we’re not here to get you your LLC doctorate. We’re here to generally introduce you to important LLC concepts so you are aware of them and can intelligently discuss them with your family, business associates and professional licensed advisors before starting an LLC.

An LLC is an “artificial entity” as contrasted to a "natural" flesh-and-blood person. It is an unincorporated business organization created by filing articles of organization with the Secretary of State or other government agency. Filing provides formal public recognition of the LLC, identifies it, and notifies the public of its limited liability.

Upon acceptance of the articles, the state will issue an LLC charter. Your LLC will have the capacity to own property, conduct business, sue and be sued, all in its own name, separately and distinctly from its “members” and “managers”.

Since the 1990s, starting an LLC instead of a corporation or partnership has become very popular in all fifty states for a wide range of creative uses. They are commonly used in asset protection plans, estate planning, real estate investment, and gifting, as well as for conducting small and large business enterprises. They are also the most common form of business entity used outside the United States.

FORMATION

Basic Information Included in the Articles of Organization:

• The LLC Name: The name must not be deceptively similar to the name of any other entity filed in the state. The name must also include an appropriate ending to identify it as a limited liability company. Acceptable name endings typically include: “Limited Liability Company”, “Limited Company”, “Ltd. Liability Company”, “Ltd. Liability Co.”, “Limited Co.”, “Ltd. Co.”, “LLC”, or “LC”.


• Registered Office: The physical street address of its principal place of business, or its registered office address, within the state.


• Resident Agent: The name and physical street address of its resident agent within the state (for service of process).

• Management: Whether the company will be managed by its members, or managed by managers.


• Members’ or Managers’ Names: The names and mailing addresses of the initial members if the LLC is member-managed; or, the names and mailing addresses of the initial managers if the LLC is manager-managed.


• Company Duration: The final date upon which the LLC will be terminated. This may be for a period of years (for example, 30 years) from the date of starting an LLC, or in states where permitted it can be of perpetual duration.


• Company Purpose: This may be stated as “Any and all lawful purposes” or this clause may be used to restrict the company purpose (and thereby restrict the powers of members or managers).


• Additional Information: You may wish to include other information such as any limitation on the powers or duties of members or managers; or capitalization limits, etc.

• A general partnership with limited liability
• A limited partnership where the owners can participate in management and still retain limited liability protections
• An S corporation without the ownership, distribution, voting and tax restrictions
• A closely held family corporation with pass through tax benefits
• A sole proprietorship with owners’ liability protection
• An entity that can raise initial capital without the restrictions placed on newly-formed corporations

• Principal place of business
• Registered office and registered agent
• Business purpose of the company
• Members’ names and addresses
• Members’ rights and duties
• Actions and proceedings of the members and managers
• Members' contributions to capital
• Managers’ rights and duties
• Accounting method
• Allocations of income, taxes, distributions, etc.
• Transferability of membership interest
• Dissolution or termination of the company
• Requirements for company formalities such as holding meetings, voting, elections, etc.
• Other provisions
MANAGEMENT

You can be very creative when starting an LLC and styling your LLC’s management structure. LLCs can be managed by the members (owners), or by managers elected by the members. You will usually stipulate when starting an LLC which style you will use in your articles of organization and operating agreement. The LLC form offers broad flexibility when designing the management structure of the company.

Member-Managed

Member managers directly control the day-to-day operation of the LLC’s business enterprise. All members may be capable of binding the company and making management decisions, or certain members may be assigned to manage different aspects or departments of the business.

A managing member may exercise control over an LLC’s affairs without holding a majority of the membership interest. This is more difficult to do using a corporation.

When a member is also a manager, it is important to remember there can be added tax consequences. For example, a managing member may be treated as self-employed for income tax purposes. In that case, the managing member will be subject to paying self employment taxes on their share of their profit distributions. (The self-employment tax rate is 15.3%. The rate consists of two parts: 12.4% for social security (old-age, survivors, and disability insurance) and 2.9% for Medicare (hospital insurance).* (*Source: IRS website article, IRS Self Employment Tax.)

Manager-Managed

LLC members may instead choose to elect managers to run the company. Managers may or may not be members, and will be appointed or elected according to the requirements in your operating agreement. Again, you have much flexibility when starting an LLC and drafting the operating agreement clauses that address the company management.

Managers directly control the day-to-day operation of the LLC’s business enterprise. Managers may be delegated full authority to bind the company and make management decisions. Or a manager may be restricted to certain duties or have limitations on their power.

Managers may be designated as “manager”, officer”, “director” or other titles. They may be elected periodically, permanently appointed, or appointed to serve until the occurrence of some future event, milestone, or until removed for cause.

Managers may be other business entities, such as a corporation, partnership or other LLC. This feature is not usually found under state general corporation statutes in the U.S. (However, for an example of one exception see Florida's For Profit Corporation "Help" web page section subheading Officer/Director > Entity Name. Also, it is a common practice in many offshore tax haven jurisdictions to permit corporations to serve as the officers and directors of corporations.)

The upside, here, is the broad flexibility available to you and your professional advisors when starting an LLC structure. The down side is that 1) you must be careful to thoroughly document the management powers and limitations in the LLC operating agreement; and, 2) the relatively brief history of LLC use in the United States means that there is not the vast body of legislative and judicial precedence found in corporate law.

TAX CONSIDERATIONS

By default, when starting an LLC, it is considered an unincorporated business organization that is a “pass through” entity for federal tax purposes. Pass through entities do not generally pay income taxes. Instead, they "pass through" any profits or losses to their owners who include their share of the profits or losses on their tax returns. Pass through tax treatment is also granted to general and limited partnerships and S corporations; however, those entities have limitations and restrictions – catches, if you will – not inherent to the LLC business form.

Generally, for federal tax purposes the IRS can categorize a business entity either as a corporation, partnership, sole proprietorship, or they can disregard the entity. When the entity is an unincorporated business organization such as an LLC, the IRS has a “check-the-box” form you may use to choose your preferred tax treatment for your company. For example, an LLC that has at least two members (owners) is treated by default as a partnership (a "pass through" entity); however, it may instead elect to be taxed as a corporation. Single-member LLCs may elect to be taxed as either a corporation, sole proprietorship, or as a disregarded entity.

State and local taxes should also be considered when starting an LLC. For example, as of this writing, California taxes an LLC at the corporate rate of 8.4% with a minimum tax of $800 per year, and it may be subject to a fee based on its total annual gross worldwide income.* (*Source: California Franchise Tax Board website article, LLC "Filing Guidelines" )

Clearly, there are many advantages and disadvantages to the tax treatment you choose when starting an LLC. If you understand your basic options before starting an LLC, you can then have an informed discussion with your professional tax advisor about how they will affect you, your family and business partners. You want to plan ahead so there are no big surprises down the road.

FORMALITIES

There is some discussion regarding the importance of observing LLC formalities. While the LLC can be made simple to operate and maintain, it is still an artificial entity that provides a “veil” of limited liability protection. As such, formal proceedings that are properly documented in company records when starting an LLC – and faithfully continued thereafter – can reinforce that veil. These include:


• Having – and abiding by – the operating agreement
• Holding regular, general, or annual meetings of the members and managers
• Adopting resolutions
• Recording and keeping minutes of formal meetings
• Keeping separate financial accounts – never co-mingle company and personal funds, income or expenses
• Keeping separate company books
• Dealing with the company at an “arm’s-length”
• Operating the company as a business (not as a hobby)

If you achieve any measure of financial success, if you live in the United States, if your company and assets are located within the United States, you have a great chance of finding yourself entangled in some sort of litigation before you die. It may take the form of a bankruptcy, divorce, lawsuit, IRS tax audit (personal AND company/ies), judgment, lien or seizure. When that happens (not “if”) your adversary's lawyers will do their damnedest to pierce your company veil to get at its assets – AND your personal assets. If you have neglected your company by not observing regular company formalities – from properly starting an LLC, and then maintaining it – you will regret it.

Take heed. Forewarned is forearmed!

For more in-depth coverage of what, when, where, why, and how to conduct or observe company formalities, please click here.






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