The Ins and Outs of LLCs
Limited Liability Companies, commonly known as LLCs, offer their owners (“members”), as the name implies, limited liability protection. LLCs are a relatively straightforward means of structuring a small business, and they are a great option for many business owners.
Setting up an LLC
For a single-member LLC, you simply must register with your secretary of state as an LLC, and typically pay a small fee to do so. That can all be accomplished in one computer session.
A multi-member LLC is a bit more complicated:
- You must create an “Articles of Incorporation” document;
- You should form a Corporate Agreement among shareholders (members); and
- You must then register as an LLC.
The articles of incorporation document technically also serves as the corporate charter, so a corporate agreement is not strictly required. But if you are going into business with someone, it’s always a good idea to have an agreement, just in case conflicts or confusion arise later on. Just as two people get married might have the best of intentions, but sign a prenuptial agreement in case problems arise, you’ll want a corporate agreement for your LLC in case the other member(s) and you end up having problems, and/or need a “divorce.”
Make sure that when you are setting up an LLC, you establish separate checking accounts, credit cards, etc. for the LLC, even if you’re the sole member. Aside from the initial capital contributions, which will necessarily come from your personal account, you do not want to comingle personal assets with those of the LLC. With separate accounts, there’s no question of which assets belong to the LLC and which are your personal assets. This is very important so that, if someone sues your LLC, they can’t also go after your personal assets.
Benefits of owning an LLC
There are considerable risks involved in running your business as a sole proprietorship, which is not a separate entity, even if you use a business name. For example, if you’re a painter “doing business as” (dba) “Quality Painting,” you are still personally liable for everything your business does, including something an employee does. Similarly, if you and a buddy form “Quality Painting Partners” as a general partnership, each of you is liable for business debts. You generally want to avoid being in a general partnership because you’re not only personally liable for your own actions in the business, but for things your partners might do, too.
The main risk of either of those business structures, therefore, is that you can be sued for your personal assets. There are some industries where being a sole proprietor is fine, but if you’re in an industry where there’s any significant risk of litigation, you’ll want to operate your business via some type of legal entity that shields your personal assets. Industries where this is especially important include financial professions, law firms, and medicine, but it really applies to any business that you can imagine someone suing if something goes wrong. Sadly, in today’s litigious society, that can be almost any business. One of the simplest means to shield your personal assets is an LLC.
LLC versus S Corp or C Corp
Aside from limiting legal exposure, you can, with an LLC, later elect to be taxed as an “S” corporation (S corp). An S corp election means that you choose to have your business taxed and file returns as a separate corporation, instead of just reporting its income and expenses on your individual tax return. There are also potential payroll tax savings to do this. As a rule, once your LLC’s net income reaches about $100,000, you should look into being taxed as an S corp.
LLCs are less convoluted and require less paperwork than other corporate entities. They also convey some major tax benefits relative to a “C” corporation (C Corp), which is how most corporations listed on stock exchanges are structured. C corps are subject to double income taxation; profits of a C corp are taxed at the corporate level, and then again by shareholders, who must pay income tax on earnings that are paid out as dividends. In contrast, LLCs, like S Corps (and sole proprietorships and general partnerships), are “pass-through” entities for tax purposes. This means that profits are not taxed at the entity level, but instead pass through to owners’ (members’) individual income tax returns, and are only taxed there.
Ideally, you should form an LLC before you start doing any business activities. That way, all of the activity is done in the name of the LLC; there’s no co-mingling, so there is a clear distinction between personal and business activities. On the other hand, if you now operate as a sole proprietorship, it may still make sense to establish an LLC so that all future business can be done through that separate legal entity.
If the benefits of an LLC, e.g., flexibility, tax advantages and liability protection, sound like they make sense for your business, look into it further. The relative simplicity of LLCs also means they are a pretty low-risk and low-cost option. If you’re wondering if an LLC is right for your situation, consider reaching out to your attorney or a financial advisor for assessment and guidance. This can also include evaluating which type of retirement plan your LLC should use, and how all of these things fit into your overall financial situation and plans.
Viridian is an SEC Registered Investment Advisor (RIA) with clients across the United States. Viridian offers financial planning, asset management, employee benefits advice, as well as tax services through its sister company, Viridian Tax and Accounting. Joe Erickson is a Certified Public Accountant (CPA) and Viridian shareholder who works for Viridian Tax and Accounting.