What does it mean to form a limited liability company (LLC)?
Many entrepreneurs have questions about this entity. If you decide to form an LLC for your business, it’s important to understand what an LLC is and why this entity can benefit your business.
What’s an LLC?
An LLC is a business structure which legally separates the business from its owner.
Typically, the default entity formation is a sole proprietorship. This entity allows its business owner to act as the boss of the business. The owner is responsible for everything, good and bad, which impacts the company.
Many entrepreneurs choose to incorporate as an LLC because it provides limited liability protection. Limited liability helps create a separation between professional and personal assets. This ensures your personal assets, like houses and cars, are not impacted by unforeseen circumstances.
LLCs and Corporations: What are the Differences?
Is incorporating as an LLC is the same as forming a corporation?
While it is true it shares similarities to a corporation, they are still separate entities. Corporations are much more structured. These entities require substantial recordkeeping and follow strict guidelines for business operations.
However, an LLC has more flexibility. The flexible nature of it means entrepreneurs may form as one of three structure types which best fit their needs.
Three Types of Structures
Here are three structures available to members.
Single Member
A single member LLC is easy to associate with its name. Only one member may run a single member LLC. If it has only has one member, this member will run the company. The single member is then treated as its own separate, legal entity formation.
Member Managed
A member managed LLC is ideal if it has a few members which would all like to run the business together. Under this structure, every member runs the business as equals. This means each member shares the same amount of responsibility in the LLC’s day-to-day operations.
Manager Managed
In a manager managed LLC, a board of managers is appointed to oversee the direction of the company. The board of managers do have a bit more control than the LLC’s members. However, this slight trade-off ensures the business is in proper operations.
Taxation Benefits
One of the reasons why it is popular with entrepreneurs is because of the entity’s taxation benefits.
An LLC is a partnership on the federal level. However, you may elect to tax it as another entity. LLCs have a pass-through entity status. They are taxed as pass-through entities. This means the profits of the business “pass-through” to the LLC’s members. These members report profits and losses on their individual tax returns. Losses and operating costs of the LLC may be deducted on personal tax returns, which helps to offset other income.
What happens if you decide to take money out of the business as income, like drawing a salary from the LLC’s profits? This business income is subject to self-employment tax. Incorporating makes tax obligations easier.
Small businesses may avoid significant self-employment taxes if they elect an S Corporation. Much like an LLC, this entity also has flow-through taxation. The corporate income, profits, and losses pass-through to shareholders which elect S Corp status. Shareholders are taxed at individual income tax rates to avoid double taxation.
Drafting an Operating Agreement
Before you decide to file, consider drafting an operating agreement.
LLCs have fewer annual requirements and formalities than entities like corporations, for example. Drafting and maintaining an operating agreement is not a requirement. A good recommendation is creating an operating agreement.
Inside an operating agreement are rules and regulations for keeping your business running smoothly. These include the rights and responsibilities of each member and the members’ ownership interest. Additionally, this document covers how to conduct business meetings, take votes, allocate revenues and losses, and provisions.
Think of an operating agreement as the roadmap necessary for the business. With it, you will be able to successfully operate and ensure success.
Ready to form an LLC? Our team of professionals at MyCorporation are ready to assist you. Reach out to us at mycorporation.com to incorporate the business.