What Is An LLC? (Benefits, Cost, Best State & More)
Whether you’re totally new to the world of limited liability companies, or you just need a refresher course, welcome to LLC Education! While the LLC is a relatively simple business structure, there’s still loads of important information to consider if you’re looking to form an LLC, or even maintain an existing one.
With that in mind, let’s dive into some common questions regarding America’s favorite business structure!
What Is an LLC?
A limited liability company mixes elements of sole proprietorships and corporations, essentially giving entrepreneurs the best of both worlds. LLCs are taxed similarly to sole proprietorships in that the owners include any company profits or losses into their personal returns — the LLC itself does not owe income taxes.
There are similarities to corporations too, especially when it comes to financial responsibilities. In an LLC, the owners or members are not usually personally accountable for the financial status of the business. This means that if someone sues your LLC, your personal assets are not at risk.
In short, LLCs are so popular because they provide a variety of legal protections for your business, while also enhancing your company’s credibility. Keep in mind as we go through this guide that if anything starts to sound overwhelming, there are services that can help you through any step of the LLC formation and ongoing compliance processes.
What Are the Benefits of Forming an LLC?
There are many benefits to forming an LLC, one of which is the relatively simple formation process. It can be a bit of a hassle, but I believe most entrepreneurs should be able to successfully form their own LLC, as long as you have enough time to make sure every step is completed correctly.
There are many ongoing benefits to LLC formation, with these being the primary factors:
- Limited Liability Status – The main reason to form an LLC is the liability protection you receive as a member/owner. You are not personally responsible for debts incurred by your LLC, and this often carries over to court judgments as well. If your company is sued, your personal assets are still protected.
- Tax Flexibility – With a new LLC, the members/owners get to choose what type of taxation they prefer. The three main options are:
- Single-member LLC – As the name would indicate, this form of taxation is similar to a sole proprietorship. There’s no direct taxation on business profits or losses; instead, business income and expenses are taxed through a sole member’s personal return.
- LLC Partnership – With this option, the IRS treats your LLC like a standard partnership. Income and expenses pass through the company to the owners, who then pay taxes on their share of profits, or deduct their share of losses, on their individual returns.
- LLC files as Corporation – In this structure, owners aren’t individually responsible for the company’s liabilities and/or debts. Creditors cannot come after your personal assets as an owner to pay your LLC’s debts.
- Less Paperwork Required – LLCs are governed by a set of default rules which vary a bit by state. It’s a flexible business model that requires far less documentation than a corporation, for example. The compliance requirements are less strict, meaning they’re not just easier to form, but they’re also simpler to maintain in good standing.
Depending on the nature of your business, there may be other advantages as well, but in general, these are the most common ones.
How Much Does It Cost to Form an LLC?
Each state charges a filing fee when you form your LLC, with a broad range of variation in pricing.
For example, the least expensive state for LLC formation is Kentucky, where it costs just $40. On the other hand, entrepreneurs in Illinois and Massachusetts are required to pay a $500 fee to the state to form an LLC. The nationwide average runs right around $136, just be aware that some states charge far more and some charge much less.
If you’re looking for a service provider to assist you with your LLC formation, there are many options like IncFile and LegalZoom. These companies can handle your LLC filing for anywhere from $50 to $400, and also offer a wide range of other services for business owners.
What’s the Best State to Form an LLC?
To be perfectly honest, sometimes the popular conceptions like “Delaware is a great state for LLC formation” or “Nevada doesn’t charge business income tax” are a bit overblown, or at the very least they’re overly generalized. In fact, in many cases the simplest and cheapest answer to this question is just to form your LLC in the state you’re already based in.
Still, there are some states that stand out from the rest due to certain advantages that they hold. Let’s take a look at a few examples:
- Delaware – A unique advantage to forming an LLC in Delaware is the Chancery Court, which is a specialized court that hears exclusively business matters. Because Delaware is the only state with a court like this, any legal matters your business encounters will be resolved quickly instead of taking years like it can in some other states.
In addition, Delaware LLCs benefit from their rather loose restrictions and minimal tax burdens. Generally speaking, Delaware is also a great choice for public corporations, and for companies that transact business in multiple states.
- Nevada – There’s a reason Nevada has a reputation as a tax haven — they have no state business income tax, capital gains tax, inheritance tax, franchise fees or state corporation tax. Because the gaming industry generates such a tax windfall, Nevada doesn’t need to rely on traditional forms of business taxation, which can help keep more money in your pocket.
Aside from all the tax breaks, Nevada also allows for anonymous LLC membership, which can safeguard you from many types of lawsuits. In fact, there’s not much information disclosure required in general from Nevada LLC owners, meaning there’s an enhanced level of personal privacy involved.
- Wyoming – While not quite as popular as Nevada, Wyoming shares many of the same benefits. There are no business taxes or franchise fees, and you can retain your anonymity as an owner if you want to. Furthermore, Wyoming also has an extremely low $52 annual fee for LLCs, which is one of the lowest in the nation.
One unique advantage to Wyoming is something called the “lifetime proxy.” This allows you to designate someone to vote on your behalf in matters pertaining to your LLC. Why? Much like the anonymous ownership allowances, a lifetime proxy gives you the option to further mask your identity by having someone else hold your membership shares while you maintain the actual power.
Should I Use an LLC Formation Service?
There’s a few factors at play here, primarily whether you want to spend the extra money to hire a formation service. If you do have the room in your budget, it can be nice to let someone else handle the hassles of assembling all of your formation documents.
Beyond just the hassle though, any mistakes in your formation documents can cause major snags down the road. The peace of mind offered by LLC formation providers is a big part of their value, as you can be confident that your documents are filed correctly by professionals who do this for a living.
Plus, these services often offer valuable perks along with LLC formation. For example, some companies like IncFile and Active Filings include registered agent service (more on that shortly) in bundles with LLC formation service. In IncFile’s case, their $49 price tag for LLC filing is considerably cheaper than paying for a year of registered agent service, which is included with LLC formation. At that point, why not have them handle your formation too?
Which Is the Best Business Structure?
The limited liability company is the most popular business structure in the US, but that doesn’t mean it’s right for absolutely every business. Let’s discuss how an LLC stacks up to a couple other common business designations.
One alternative to forming an LLC is to obtain a Doing Business As (DBA) name, which allows you to conduct business under an assumed name. With a DBA, you get many of the same advantages of an LLC, like the ability to open bank accounts and accept payments under your alternate name. This enhances the credibility of sole proprietorships and other very small businesses that don’t need all of the protections provided by the LLC structure.
However, a DBA offers no protection from lawsuits, and does not provide limited liability status. With a DBA, you can be personally sued for the business actions of yourself, your partners or your employees. Additionally, there is no special tax status provided by a DBA — the individual or entity conducting business will still file taxes just as they would without the DBA.
On the other end of the spectrum is another option: forming a corporation. Unlike LLCs, corporations have formal management and ownership structures with clearly defined roles for the company directors and officers. However, corporations do give business owners a variety of options for taxation.
The S-corporation is taxed much like an LLC with the “pass-through” method, whereas the C-corporation is taxed as a separate business entity. Additionally, corporations allow for greater flexibility when declaring business losses, determining stock interests and variable dividend scales, and more.
All of these options have their advantages and disadvantages depending on the nature of your business. In general, the popularity of the LLC format is due largely to the level of legal protection it provides, while giving business owners the option for flexible company structures.
What Is an LLC Operating Agreement?
An operating agreement is a crucial step for any LLC, because it defines your company structure, while detailing ownership rules and operating standards. For an LLC with more than one owner/member, the operating agreement is especially crucial because it defines each partner’s responsibilities and roles. This helps prevent unwanted misunderstandings down the road.
The information in your LLC operating agreement might vary a bit depending on your state of formation and the nature of your business. For the most part, an operating agreement should include all of the following info:
- Each member/owner’s identities and specific roles
- The rights, voting power and percentage interests of each member
- Plans for the allocation of profits and losses
- Management structure outline
- Rules for meetings and the casting of votes
- Proposed actions for replacing a member if necessary
The operating agreement isn’t a legal necessity for most LLCs, but it is still a vitally important step in the LLC formation process. In addition, an operating agreement doesn’t have to be fancy or complex — it’s a simple document that can help you avoid some tricky legal issues down the line.
What Is a Registered Agent?
Registered agents are third-party entities that receive official documents for your LLC. From notifications of lawsuit filings to government correspondence, important legal documents are the responsibility of your registered agent, who ensures that you receive notice of the document before forwarding it to you. This cuts out many surprises, as you’re never going to miss a vital piece of mail.
The reason for registered agents is that they provide a reliable means of making official contact with your company. Without one, business owners could duck compliance requirements while hiding behind the excuse of not knowing anyone is trying to get ahold of them. Likewise, a company that’s entirely within compliance guidelines could get sued without their knowledge.
There are some states that allow you to be your own registered agent, but we don’t advise serving as your own agent. If you do, you’ll have to be available during all standard business hours, and also willing to allow your personal address to become public record.
What Is an EIN?
An employer identification number (EIN) — also known as a federal tax ID number — is a Social Security Number for your business. The majority of LLCs do require an EIN for things like opening business bank accounts, filing company taxes, hiring employees, etc.
There are other benefits to obtaining an EIN as well. One of the main reasons to get one is because you can use it instead of your Social Security Number, which is clearly a big privacy benefit. You also might need an EIN for business licensing purposes.
What Is an Annual Report?
These are simple documents filed with your state to keep them informed of a few basic pieces of information on a yearly basis.
Typically, these forms include your company address, the nature of your ownership (foreign or domestic), at least one member/owner’s name and address, etc. It’s important to keep the state’s records up-to-date when it comes to these important company details.
There’s a reason the LLC is the most popular business structure in America today. The flexible structure is greatly appreciated by a wide variety of companies, and the taxation options are welcome as well.