A limited liability company (LLC) is a business entity that combines an owner-friendly tax structure with limited protection from legal and financial liabilities.
Factor in management flexibility and ease of formation and you'll understand why this type of company has been the most popular choice among small business owners since an IRS ruling clarified the tax status of the new and innovative corporate structure in 1988.
If you are thinking about structuring your sole proprietorship as a limited liability company or want to start a completely new business but don't know how to create an LLC, I suggest you read on. At Kabir International Group we can guide you and do the process for you, but we like all our clients to understand what they are doing. Especially when we are creating a new company.
In this guide we are going to see how is the process of creating an LLC, we will share all the important steps you should take after forming your company and we will explain all the differences between LLCs and other popular entity structures.
Table of Contents
1. Advantages of forming an LLC
2. Disadvantages of forming an LLC
3. How to create an LLC in six easy steps
4. Important steps after starting an LLC
5. LLC versus other types of business entities
6. How to select the State of registration
Advantages of forming an LLC
The advantages of structuring your business as an LLC - rather than operating as a general partnership or sole proprietorship, or creating a corporation - outweigh the disadvantages in most cases.
Limited Liability: Probably the most obvious advantage of creating an LLC is to protect your personal assets by limiting liability to the resources of the business itself. In most cases, the personal assets of the LLC members will be protected from legal claims against the company.
Pass-through taxation: As "pass-through" or "flow-through" entities, LLCs do not pay any entity-level taxes as do C corporations. LLC income is passed through to the members, who report it on their personal tax returns.
Flexible Membership: Unlike S corporations, which are much more restricted as to who can be a shareholder, LLCs have the advantage of membership flexibility. Members (owners) can be individuals, partnerships, corporations and trusts. There are no limits on the number of members.
Management: Unlike corporations, which are managed by a board of directors, LLCs can be managed by their own members or by a management group.
Increased credibility: Creating an LLC can help a new business increase its credibility, especially compared to businesses operating as partnerships or sole proprietorships.
Limited compliance requirements: Businesses structured as LLCs face fewer state-imposed formalities - such as annual compliance requirements - than almost any other type of business.
2. Disadvantages of forming an LLC
There are also some disadvantages to forming an LLC. However, in most cases, the advantages far outweigh the disadvantages of this type of corporation.
Cost: Compared to a partnership or sole proprietorship, an LLC can be a bit more expensive to form and maintain. In addition to formation fees, many states also impose ongoing charges, such as annual report fees.
Transferable Ownership: Transferring ownership is more complicated with an LLC than with a corporation. In most cases, all members must approve changes in the ownership percentages of existing members and the addition of new members.
3. How to set up an LLC in six easy steps
As long as you know what you're doing, setting up your own company doesn't have to be complicated, especially if you decide to structure it as a limited liability company. However, while the procedure for setting up an LLC is not as complex as that of a corporation, there are several steps you need to follow to make sure you've done everything correctly. To help you get started, we've broken down all the activities involved in forming an LLC into six steps.
1. Choose your state of incorporation
Although the law allows you to form an LLC in any state-even if your business won't operate there-most new business owners choose to form an LLC in the state in which they live, which is usually also the state in which they plan to do business.
When choosing a state of incorporation, it is important to remember that registration costs, tax rules and LLC laws can vary widely from state to state, making some parts of the country more favorable to certain small business owners. Because of this, some entrepreneurs assume that they will save money by incorporating in a low-rate state (such as Delaware or Nevada), even if they do not plan to do business in that state.
Keep in mind that limited liability companies incorporated in one state but operating in another must obtain a foreign qualification in each state in which they operate. In other words, if your business will have any type of physical presence (offices, storefronts, sales representatives, etc.) in different states, you will need to register a foreign LLC in each state of operation. Keep in mind that this can significantly increase your administrative expenses.
2. Naming Your LLC
There are two important aspects to choosing a name for your new LLC.
First, you need to choose a name that has not already been taken by another domestic or qualified business entity in your state of incorporation. To determine if the name you want is available, conduct a search on the Secretary of State's website. If you are not yet ready to file LLC formation documents, we recommend that you reserve the name you like. Most states allow you to make a temporary reservation of the company name for a small fee.
On the other hand, we also suggest that you conduct a trademark search of the name you want to make sure that it does not confuse your customers or infringe on any intellectual property rules.
Second, your business name must comply with certain regulations specific to the LLC's state. Although each state has somewhat different rules regarding LLC names, there are some general guidelines:
The phrase "limited liability company" or its abbreviation (LLC or L.L.C.) must be part of your business name.
Words that could confuse your limited liability company with a government agency are prohibited, as are the terms "corporation" and "incorporated".
Words such as "insurance," "attorney," "bank," or "university" are prohibited unless a licensed person, such as an attorney or physician, is part of your LLC. Note that the formation of your company may require some additional paperwork in this case.
3. Appoint a registered agent
An LLC's registered agent (also called an agent for service of process) is a person or company that sends and receives official correspondence, such as filing documents and legal subpoenas on your behalf.
Whether you are forming a new LLC or registering an existing LLC to operate in a foreign state, you are required by law to designate a registered agent with a physical address (not a post office box) in the state of registration.
Although one of the LLC's owners can also represent the company as its registered agent, we strongly recommend hiring a professional for this liability work.
4. Register your LLC with the state
To officially create an LLC, you will need to file the formation document with the secretary of state's office. This document is better known as the LLC articles of organization, however, in some states, it is known as the certificate of formation or certificate of organization.
Although no two states have exactly the same LLC registration documents, for the most part they consist of common elements such as:
Company name, purpose and principal location
Name and physical address of the registered agent
The management structure of the LLC (member-managed or manager-managed).
Please note that you will be charged a state filing fee, which may vary in the United States. Once your application is approved, you will receive a confirmation document. Issued by the state, this document serves as proof of the LLC's legal status and can be used to obtain an EIN and open a business bank account.
In some states, you may also be required to publish a notice of LLC registration, usually in a local newspaper. Such as, for example, New York.
5. Creating an LLC operating agreement
Although most states do not officially require it, we recommend that you create an operating agreement for your LLC. This internal document outlines the roles of the members and ownership structure of your new company. If you choose not to create an operating agreement, state laws will dictate the operation of your LLC.
An LLC operating agreement has the following six main sections:
Organization: states when and where the LLC was created, lists the members of the company, and describes its ownership structure.
Management and Voting: Addresses how the company will be managed and describes the rights, responsibilities and voting powers of the members.
Capital Contributions: Lists the members who will financially support the LLC and outlines a plan for how additional funds will be raised in the future.
Distributions: Describes how the profits and losses of the LLC will be distributed among its members.
Membership Changes: Covers the process of adding or removing members along with the mechanism for transferring ownership shares.
Dissolution of the LLC: Defines the circumstances under which the corporation may be dissolved.
6. Obtain an EIN
After your LLC is officially created, you will need to apply for an EIN in order to open a business bank account and hire employees. Provided by the Internal Revenue Service (IRS), an Employer Identification Number (EIN) works like a Social Security number for your business.
Note that even if you do not plan to hire employees, but have formed a limited liability company with several members, you will need this identification number. You can acquire your EIN by filling out an application form online, by phone or by fax. You can also hire an LLC service provider to do it for you.
In addition, in each state in which you operate, you will need to apply for a sales tax identification number from the state Department of Revenue and register with the Department of Labor.
4. Important Steps After Starting an LLC
Congratulations, you have formed your limited liability company. Don't spend too much time celebrating, as you still have some post-formation work to do. Here's a rundown of all the additional steps you'll need to take before you officially open for business.
Open a business bank account
While this step may not be considered a legal requirement, separating your business finances from your personal finances by opening a separate business bank account is a key practice for new LLC owners.
If your personal and business assets are commingled, you run the risk of losing your personal valuables (such as your home and car) in the event legal action is taken against your LLC. That's why it's necessary to use separate bank accounts to protect your company's corporate veil.
Applying for a business bank account is simple and easy. At most banks, you will be asked for some basic information, such as the date of incorporation of the LLC and the names and addresses of the owners. Since some banks may have additional requirements, we suggest that you contact the provider of your choice before opening an account.
Register your LLC with the relevant tax authorities
As for state taxes, both the nature and location of your business will determine your LLC requirements. You may even have to register for various state tax forms. The most common forms include
Sales and use tax: If you will be selling products and collecting taxes from your consumers, you will have to remit a percentage of the sales price to the government.
Franchise tax: Although not required nationwide, this tax is based on an LLC's annual income.
Withholding tax: This type of tax, which is withheld from employees' paychecks to give to the government, is paid by business owners who have employees.
Unemployment Insurance (UI) Tax: UI tax rates are set by state law. Funds accumulated through this form of tax are used by the government to cover unemployment benefits.
Establish bookkeeping.
Keeping track of your LLC's finances can be daunting, but it must be done correctly. If you are a new business owner, you will be surprised at the amount of expenses you will have to keep up with even before you officially open for business.
As soon as you register your LLC, you'll need an effective accounting system to help you monitor your business finances (including invoices, income and expenses), plan your budget for the operation and growth of your LLC, and simplify your annual tax filing.
If you can't handle this aspect of the business yourself, we recommend hiring a certified accountant or exploring the best accounting software options.
Obtain LLC licenses and permits
Depending on the nature of your business, you may need to obtain certain licenses and permits to get started and remain compliant. While business license requirements often vary based on the laws of your state, county and city, some business activities require permits and licenses at the federal level. These include the following activities
Agriculture
Aviation
Alcoholic beverages
Ammunition and firearms
Explosives
Fishing and wildlife
Maritime and river transportation
Nuclear energy
Mining and drilling
Television and radio
Transportation and logistics
If you need help researching LLC licensing requirements for your business and filing applications, we suggest you hire a professional. Most companies that offer LLC services make business licensing part of their portfolio and provide comfort and assurance that you will get everything you may need.
Get insurance for your business
Business insurance protects businesses from financial damages due to unexpected events such as accidents, professional errors, property damage, workers' compensation claims, etc. There are several types of business coverage you should consider, especially as a small business owner:
Workers' compensation insurance: Mandatory in nearly all 50 states, this type of insurance covers work-related injuries, illnesses, rehabilitation costs and lost wages, regardless of who is at fault.
General liability insurance: Also known as commercial liability insurance or small business liability insurance, this type of coverage protects your business against claims such as bodily injury, property damage and advertising liability. Although you are not required by law to carry general liability insurance, we strongly recommend that you do so. Without this type of coverage, a lawsuit could force your LLC out of business.
Professional liability insurance: Also known as errors and omissions coverage, this type of insurance protects you if you don't do something you should have done, or if you end up doing something you shouldn't have done. Professional liability insurance also protects you from mistakes made by your employees and subcontractors.
Follow contracting laws
Your business is expanding and you want to bring on your first employees. While that's great news for your limited liability company, keep in mind that the hiring process comes with several legal requirements. Here's what you'll need to do:
Make sure your prospective employees can work in the United States. In some situations, the services of background check companies may be helpful.
Report your new hires to the State.
Provide all employees with workers' compensation insurance.
Withhold taxes from employees.
Pay your workers at least the federal minimum wage, as often as your state requires.
5. LLCs versus other types of business entities
In addition to LLCs, S corps (also known as S corporations, subchapter or small businesses) and C corps (C corporation) are the other two main types of for-profit business structures. Each of these business types has its own advantages and disadvantages.
In deciding whether to create an LLC, a C corp or an S corp, you will need to consider several factors, such as taxation, flexibility, ownership structure and treatment of stock or shares.
To help you choose the best type of entity for you as a business owner, we've broken down the differences and similarities between the three business structures.
TYPE OF ENTITY | RESPONSIBILITY | TAXATION | MAINTENANCE |
Limited Liability Company (LLC) | It combines limited liability protection with a pass-through tax structure. | IRS rules allow LLCs to choose between being taxed as a partnership or a corporation. | It is the easiest entity to maintain with the fewest formal annual requirements. |
Corporation | Owners/shareholders have limited personal liability for debts related to the business. | Separate taxable entity, corporate profits between the owners and the corporation. | Meetings are required to maintain corporate status. Shares can be sold to raise capital. |
Non-profit corporation | A corporation formed for charitable, educational, religious, literary, or scientific purposes. | Contributions to a charitable corporation are tax deductible. You can obtain tax-exempt status with the IRS. | Contributions to a charitable corporation are tax deductible. You can obtain tax-exempt status with the IRS. |
S Corporation | ​An S corporation is a tax status, so any existing liability protection from your base entity carries over. | It is more expensive to set up than a partnership or sole proprietorship, but offers potential tax savings. | More formality requirements than for a limited liability company that offers similar advantages. |
6. How to select the State of registration
You should know that the United States is a federal country, where there are agencies that operate equally in all states and others where their scope of action is only their own jurisdiction.
Thus, the Internal Revenue Service (IRS) rules apply equally to all LLCs, regardless of where they are incorporated.
On the other hand, local rules imposed by the state secretary of state only apply in their own state, such as the obligation to file an annual report.
If any of the owners of the LLC or your business will have a physical presence in the United States, it will not make a difference which state you choose. Since the company must be registered in each of the states with which it has physical nexus. This applies mainly in three cases:
If any of the owners live in the US.
If there is any permanent establishment in the U.S. where the operation of the business is carried out (e.g. stores, warehouses, offices, branches, etc.).
If there is a dependent agent in the U.S., who is someone, not necessarily under contract, whose income is derived primarily from the work he/she does for the company.
Annual Report
If there is no physical nexus with the U.S., what is usually taken into account is the cost of the annual report. This is the obligation that must be fulfilled periodically for the company to remain operational (Good Standing). It is usually annual, although in some states it is every two or even every 10 years.
Each state requires a different reporting format, and therefore charges a different renewal fee.
There are 5 states that do not require annual reporting and do not charge any renewal fees: Arizona, Missouri, New Mexico, Ohio and South Carolina.
There are 4 states that do require annual reporting but do not charge a renewal fee: Idaho, Minnesota, Mississippi and Texas.
There are 41 states that do require annual reporting and also charge a fee. For example: Delaware $300, Florida $138.75 and Wyoming $60.
It is important to note that the company needs to maintain a physical address in the U.S. and a Registered Agent each year it is active.
State Taxes
In the United States, state taxes are paid whenever there is a sale of a physical product in the United States (Sales Tax). The rate that applies is that of the state in which the customer is located, i.e. where the sale occurs.
Virtually all physical products are subject to this tax, unlike digital services, which are mostly exempt. The same applies to services.
Depending on the state, the periodicity to pay them may be different (monthly or quarterly in most). It may also vary depending on the utility.
Anonymity
In the United States it is possible to open companies whose owners' information (such as name or address) has not been submitted to the state and does not appear in the state database. Therefore they are considered Anonymous Companies.
There are several states where LLCs can be anonymous, although we highlight the following: New Mexico, Wyoming, Delaware, Delaware, Ohio, Nevada, New York, Wisconsin, among others.
However, it can sometimes be counterproductive, for example, to verify that you actually own a company (even though it is formally stated in the Operating Agreement).
Commercial Intent and Prestige
By registering a company in the United States, you will have access to one of the largest markets in the world. Besides, it is a country with international recognition.
That is why when deciding in which state to register the company, you should also evaluate the commercial impact it can cause to the clients and suppliers of the newly created company.
7. Frequently Asked Questions
How can I create my own limited liability company?
You can form your LLC on your own, hire an attorney to do the work on your behalf, or use an online LLC service provider to help you go through the process. Regardless of the approach you decide on, remember that there are several steps to forming an LLC.
These include choosing your state of formation, choosing a name for your LLC, designating a registered agent, creating articles of organization and filing your paperwork with the state, creating an operating agreement, and obtaining an EIN..
Is it easy to create an LLC?
Where can I create an LLC?
How much does it cost to create an LLC?
How long does it take to create an LLC?
Do you need an attorney to form an LLC?
Do I need an EIN for an LLC?
Does an LLC file a tax return?
Can I create an LLC through the Internet?