What Is an LLC? And More FAQs About Limited Liability Companies

Millions of startup businesses have been formed as Limited Liability Companies (LLCs). Businesses as diverse as restaurants, retail stores, online companies, and real estate have elected to be formed as LLCs.

In this article, I answer 10 of the most frequently asked questions about forming and operating an LLC, including what an LLC is.

1. What is an LLC?

An LLC is a popular structure for forming a company. LLCs, S corporations and C corporations are among the most popular business structures. LLCs have the benefit of providing limited liability protection for the owners of the business, similar to a corporation. This means that the owner of the LLC, if properly operated, should not be personally liable for the debts and obligations of the business.

This limited liability protection is also available in S corporations and C corporations, but not in sole proprietorships or general partnerships.

2. What are the tax benefits of LLCs?

An LLC can provide for “pass-through” tax treatment so that there is only one level of tax and it can avoid the double taxation found in C corporations. Only the owners of the LLC are taxed (unless a contrary tax election is made, and there is no tax at the LLC level. This is similar to the tax treatment for S corporations.

3. In what state should you form your LLC?

Because an LLC is formed by filing in accordance with the requirements of a state law, you have to decide what state you should organize in. Delaware is often chosen because of its well-developed state law. But in the vast majority of situations, you should organize the LLC in your home state to save on fees, filing obligations, and complexities.

4. What is the easiest way to form an LLC?

For simple LLCs (such as when there will be a single owner), the easiest way to form an LLC is to use an online business formation service to do the work, such as CorpNet.com, MyCorporation.com, or ZenBusiness.com. For more complicated LLCs (with multiple owners or complicated ownership or management/voting rights), a lawyer experienced in LLCs may be more appropriate.

5. What are the costs of forming an LLC?

Here are some typical costs for forming and operating an LLC:

  • State filing fees—Range from $35 to $500 depending on the state.
  • Fee for service provider to form your LLC—Many online sites have different programs to form an LLC with fees typically ranging from $100 to $500. If you use an attorney instead, the fees will likely be higher, depending on the complexity involved
  • Annual franchise tax—The state will likely impose a minimum annual franchise tax, typically $100 to $800 per year.
  • Registered agent fee—Every LLC must have a “registered agent for service of process” in the state where it is registered. This is an individual or company that agrees to accept legal documents on behalf of the LLC in case it is sued. While an employee, owner, or attorney can serve as the registered agent, many LLCs prefer to hire a professional registered agent company; the annual fee is typically $100 to $400.
  • State report fee—In many states, an LLC is required to file a report (every year or every two years) with the Secretary of State, keeping the LLC’s information up-to-date. This is sometimes referred to as an “Annual Report” or “Statement of Information.” The fee to be paid for this filing usually ranges from $20 to $100.
  • Business license fees—Depending on where your business is located and the type of business, your state, county, or city may require you to obtain a business license, with a cost typically of $50 to $100.
  • Tax/accounting fees—An LLC will typically hire an accountant to prepare its required annual tax filing and produce the IRS K-1 statements that have to be given each year to the owners of the LLC.

6. What are the key documents involved in forming an LLC?

Here are the key LLC forms and documents:

  • Articles of Organization—This is the document filed with the Secretary of State to officially form the LLC. It’s sometimes called a “Certificate of Organization” by the state. It is the equivalent of Articles of Incorporation for corporations.
  • LLC Operating Agreement—This is the agreement among the owners of the LLC setting forth financial, capital contribution, management, voting, and other rights and responsibilities of the owners. Most lawyers and online services have a standard form of LLC Operating Agreement that can be tailored to your specific situation.
  • Business license application—Business license applications may be required by your state, city, or county.
  • Employee Identification Number—The IRS requires that you obtain an Employee Identification Number (EIN) for your LLC, which you can easily apply for online here. The IRS does not charge a fee for this.
  • DBA—If you plan to operate the LLC under a name different than the business name on file with the state, you may need to file a DBA (“doing business as”) name form.
  • Bank account forms—It’s important that your LLC has its own banking/checking account to separate the company’s funds from the personal funds of its owners. Banks will require certain forms to be completed before allowing an account to be opened, together with a copy of the LLC’s Articles of Organization to show it’s a legal entity.

7. What can I name my LLC?

There are multiple issues in picking an LLC name:

  • The name typically needs to end with “LLC,” “Limited Liability Company,” or some permitted abbreviation thereof.
  • The name must be distinguishable from all active foreign and domestic LLCs filed with the Secretary of State (in California, you can do a preliminary search of LLC names on record at sos.ca.gov).
  • The name can’t contain some terms that may be prohibited by state law (such as “bank,” “trustee,” or “insurance company”).
  • The name can’t contain the words “corporation,” “inc.”, “incorporated,” or “corp.” (to ensure that the LLC is not misconstrued as a corporation).
  • You need to do a trademark search to ensure you aren’t violating another party’s trademark (check uspto.gov).
  • You should conduct a thorough internet search on the proposed name to see if other companies’ use of the name could cause you problems.
  • Don’t pick a name that could be limiting as you grow the business (such as “Oakland Tires, LLC”).
  • Check on the availability of getting the “.com” domain name associated with the business (as opposed to “.org,” “.net,” or some other variant).

Picking a good name is not easy and obtaining the desired domain name you want will likely involve some meaningful cost if it is already owned by a third party. For more advice on this, see 10 Tips for Naming Your Startup Business.

8. How are LLCs owned and managed?

The owners of an LLC are called “members” as opposed to the owners of a corporation who are called “stockholders” or “shareholders.” A single-owner LLC will contain one member and own 100% of the LLC interests.

Ownership in an LLC typically entitles the owners to a percentage of the LLC’s profits, losses, and cash distributions, and a right to vote on certain business decisions of the LLC. This is all set forth in the LLC’s Operating Agreement.

The LLC can be managed by one managing member, a group of members, an outside manager, or by all the members, as you set forth in the Operating Agreement.

An LLC does not have a Board of Directors, which is required for corporations.

9. What is typically contained in an LLC Operating Agreement?

The LLC Operating Agreement sets forth the owners’ financial, management, and other rights and responsibilities. Here are some key issues that should be addressed in the LLC Operating Agreement:

  • The amount of capital contributions made to the LLC by the members of the LLC, and when those contributions are required to be made.
  • Any penalties or remedies if the capital contributions are not made.
  • How profits and losses are to be split and cash distributed among the owners.
  • Whether any members or class of securities of the LLC have preferences in distributions or on liquidation (akin to “preferred stock” in a corporation).
  • Who will manage the LLC.
  • How any officers will be appointed.
  • Voting rights for major events like additional capital contributions or sale of the business.
  • Indemnification protection for the managers running the business.
  • Restrictions on transfer of LLC interests (the LLC interests are often referred to as “units”).
  • Procedures for meetings of the members.
  • Procedures for dissolution.

10. What are the principal disadvantages of an LLC?

Disadvantages include:

  • Venture capitalists and other professional investors will likely not invest in an LLC, as they prefer investing in a C corporation.
  • Transfers of ownership interests are more complicated than transfers of stock in a corporation.
  • Some states will impose a minimum annual franchise tax, plus a tax on gross revenues over $250,000.
  • For a multimember LLC, the LLC Operating Agreement needs to be carefully drafted.
  • Additional accounting fees will be incurred to issue IRS K-1 forms annually.
  • The owners of the LLC may have to pay self-employment taxes on the profits of the LLC.
  • Since there is “pass-through” taxation, if the LLC shows a profit in a year, the owners will have to reflect their percentage interest in the profits as income in their individual tax returns, whether or not they have received any cash distributions.
  • Issuing equity and employee options is more complicated in LLCs in comparison to corporations.

Should you form an LLC?

As discussed in this article, LLCs may be appropriate for simple businesses involving one owner or a small number of owners. But in more complicated situations, a C corporation or S corporation may be more appropriate.

Related articles from AllBusiness.com:

  • How to Form an LLC
  • How to Incorporate a Startup Business
  • LLC vs. Corporation: Choosing the Best Structure for Your Startup
  • Pros and Cons of a Limited Liability Company (LLC)
  • LLCs vs. S Corporations: What’s the Best Business Structure for Your Business?
  • 9 Legal Missteps That Can Sink Your New Business
  • Copyright © by Richard D. Harroch. All Rights Reserved.

    How to Turn Your Freelance Business into an LLC—And Why You Should

    While all freelancers are technically business owners, not everyone considers them such. In some instances, freelancers who don’t treat their endeavors professionally are partly to blame. But often, the lack of regard stems from misconceptions about freelancers.

    Fortunately, by considering the suggested steps below, freelancers can turn negative perceptions around and establish a foundation for success and growth.

    8 steps to make your freelance business official

    1. Choose a type of registered business entity

    Many freelancers (and other solo business owners) start out as
    sole proprietors. In a sole proprietorship, no separation exists between the individual and the freelance business for legal and tax purposes.

    While operating as a sole proprietorship is the simplest route from an administrative and business compliance standpoint, it has its disadvantages.

    Sole proprietorship drawbacks:

    Unlimited personal liability for the business’s debts: In a sole proprietorship, the business owner is personally responsible for all legal and financial obligations of the business. So, if someone sues the company, the freelancer’s personal assets—home, car, checking and savings accounts, etc.—are at risk. Likewise, business expenses and loans are tied to the individual. If the business doesn’t have funds to cover them, the freelancer’s personal assets could be used to settle those debts.

    Lack of business name freedom and protection: States require that the legal name of a sole proprietorship include the owner’s name. For example, “Lana Juarez Website Design Services.” To use a more creative name when marketing her services, Lana would need to complete a state or county filing for fictitious name use, also called “filing a DBA” (doing business as).

    Note that while an approved DBA gives a sole proprietorship the legal OK to use a fictitious name, it does not give the business owner exclusive rights to the name. Therefore, other businesses may also be able to conduct business using the same (or a similar) name.

    No tax flexibility: In a sole proprietorship, all business income and expenses flow through to the owner’s personal tax return. No other options are available. In addition to income tax, business profits are subject to self-employment taxes (Social Security and Medicare). Even if the freelancer wants to keep earnings in the business rather than withdrawing them as personal compensation (known as taking an “owner’s draw”), all taxable income is generally subject to self-employment taxes.

    Lack of credibility: Some prospective clients and lending institutions may be hesitant to work with someone who operates as a sole proprietorship. They may view an individual who hasn’t established an official business entity as less trustworthy or responsible.

    How can a freelancer overcome these drawbacks? I encourage them to consider establishing a registered business entity, such as an LLC (limited liability company) or corporation. A corporation has a great deal more
    startup and compliance formalities, generally beyond what many one-person businesses care to deal with.

    Since I’m discussing freelance professionals in this article, I’ll offer details about the LLC structure, which tends to be more well-suited to very small businesses.

    Pros of an LLC:

    Limited personal liability for the business’s debts: By forming an LLC, a freelancer creates a separate legal entity for their company. That protects the freelancer’s personal assets because, in many instances (aside from personal negligence, harm, fraud, or illegal actions), the freelancer will not be held responsible for the business’s debts or legal problems.

    Business name freedom and protection: By registering the freelance business as an LLC, a freelancer may use a fictitious name as the company’s legal name. That allows the freelancer to brand the business more creatively without needing to file a DBA. When the state approves the LLC’s formation filing, the business name is automatically registered and may be used in the freelancer’s marketing assets, bank accounts, contracts, and other documents and communications.

    Generally, states will not allow another business to use an existing LLC’s name, so the freelancer gains some important brand protection when forming an LLC. Before deciding on a business name, I encourage freelancers to conduct a business name and trademark search to confirm that another company hasn’t already claimed the name they wish to use.

    Tax flexibility: While a single-member LLC is by default taxed as a sole proprietorship, an LLC that meets the IRS criteria may elect for
    S Corporation tax treatment. S Corp election may reduce a freelancer’s personal tax obligations because only their wages and salaries from the business are subject to Social Security and Medicare taxes.

    Enhanced credibility: The formation of an LLC may give a freelancer enhanced credibility in the eyes of potential customers, project partners, and lenders. The fact that the freelancer has taken the steps to officially register their business and create an official entity can help instill trust and confidence in those who may potentially work with or loan money to the freelancer’s company.

    2. Designate a registered agent

    Most states require business entities to designate a
    registered agent. A registered agent is an authorized party (individual or company) approved to be a business’s official point of contact with the state and will accept important notices and documents on the business’s behalf.

    The types of communications a registered agent will receive for a business include:

    • Regulatory and tax notices
    • Service of process for legal notices (e.g., summonses and subpoenas)
    • Government correspondence
    • Business compliance documents

    While some states allow a business owner to be their own registered agent, that may not be an ideal scenario. States have rules regarding the specific hours and days a registered agent must be available. They also have other qualification criteria that must be met to serve as a registered agent.

    3. File LLC Articles of Organization

    In most states, the paperwork to form an LLC is called either Articles of Organization or Certificate of Organization. The information requested and the fees associated with the filing vary by state. Business owners may complete and submit the form on their own or ask someone else to assist them (such as an attorney or online business filing company).

    If a freelancer wants to be treated as an S Corporation for tax purposes, they will also need to file
    IRS Form 2553 (Election by a Small Business Corporation).

    4. Obtain an EIN and set up a business bank account

    Most banks will require that an LLC gets an EIN (Employer Identification Number) from the IRS before they will set up a business bank account for someone. Even if a freelancer doesn’t have employees, they must obtain an EIN to open their banking accounts. They may also need an EIN for other purposes, including applying for business licenses and permits.

    Fortunately, the IRS issues EINs at no charge. Obtaining one involves completing
    Form SS-4 (Application for Employer Identification Number), which can be filled out and submitted online. The freelancer requesting the EIN must provide their Social Security number or Individual Taxpayer ID number.

    5. Apply for business licenses or permits

    Whether a freelancer operates as an LLC or a sole proprietorship, they may have to hold certain licenses or permits to conduct business legally. The requirements a freelancer needs to fulfill can depend on their work location, their industry, the type of work they perform, and other factors. It’s critical that business owners research their responsibilities at the state, local, and federal levels.

    6. Use the LLC name and don’t commingle personal and business funds

    Freelancers who form an LLC must keep their personal and professional transactions and accounts separate. Invoices to clients, business contracts, and other company documents should reflect the LLC name. Also, it’s critical to make sure business funds are used for business purposes, and personal funds are used for personal purposes—no intermixing the two!

    Taking these steps helps preserve the legal separation, and the personal liability protection, of the LLC structure. Failure to maintain that division could result in a court determining the freelancer has “pierced the corporate veil” and holding the freelancer personally responsible for the debts of the business.

    7. Notify your clients and vendors

    It’s crucial for freelancers who have changed from a sole proprietorship to an LLC to notify their customers, vendors, and contractors. Anyone who pays a freelancer for services or sends bills to the freelancer should use the freelancer’s LLC name on checks and invoices.

    8. Hire employees to grow your business

    Freelancers start off as a one-person operation. Some may continue their entire careers as solopreneurs, while others may decide to expand their companies and onboard the talents of other individuals. Bringing employees into the fold comes with additional responsibilities, including payroll.

    To hire staff, a business owner must have an EIN, the ID number the federal government uses for payroll tax purposes. Payroll tax account registration at the state (and sometimes local) level must be completed as well.

    When a business has employees, it’s responsible for various employment-related taxes and fees. Some are deducted from employees’ pay, while the employer pays others.

    Examples of employment taxes and payroll deductions:

    • Federal, state, and local income taxes—These are deducted from the employee’s pay. Withholdings are based on the information the employee provides on their W-4 form.
    • FICA tax (Social Security and Medicare taxes)—The employee’s pay deduction is 7.65%, and the employer pays the other 7.65%.
    • FUTA—Federal Unemployment Tax is paid by employers. It is not deducted from an employee’s pay.
    • SUTA—State Unemployment Tax (sometimes called SUI, State Unemployment Insurance) is usually paid by employers, although employees must contribute in some states.

    A word about keeping your freelance business compliant

    Freelancers who form a registered business entity should research their ongoing business compliance responsibilities. The IRS, state, and local government websites provide information about the obligations, and insights from an attorney,
    accountant, or tax advisor can also prove valuable.

    By staying up to date with any reporting and renewal requirements, a freelancer can continue to enjoy the benefits of having a registered business entity year after year.