When To Form An LLC – Things To Consider Before Making The Decision

by | Apr 28, 2021 | Business, Business Resources

You’ve decided to start your own business – congratulations! There are many different business structures you might choose from as you’re starting out. There are s corps and c corps, and of course, LLCs.

LLCs are a widely used business structure and can provide a variety of benefits for your company. However, the choice to form an LLC is not a decision that should be taken lightly. There are many considerations to keep in mind before making the final decision, including how much money you want to invest, and what your business’s structure will be (sole proprietorship, partnership, or corporation). 

You also need to decide on which state you would like your LLC formed and whether you want it registered with the IRS. Another top question to consider: when to form an LLC? The timing of forming your Limited Liability Company can truly make or break your business, so it’s important to consider the best time to do so.

Fret not, though, this article will walk you through all the steps you need to consider as you’re weighing the decision of when to form your LLC. Not only that, though, we’ll also give you a thorough overview of LLCs so you can gain a better understanding of this structure for your business. Let’s dive in!

When-To-Form-An-LLC-Company-Building

What is a Limited Liability Company (LLC)?

An LLC is a legal entity that allows for limited liability and tax benefits. There are many reasons why one might want to form an LLC, such as if they have multiple ventures or if they have some personal assets that could be lost in the event of bankruptcy. In order to form an LLC, there are certain steps that must be taken first.

Limited-Liability-Company-LLC

There are a lot of reasons to form an LLC. Below are some of the most common. 

Limited Liability

One of the most common reasons why business owners choose to structure their businesses as LLCs is that it offers some protection from liability. With business options like a sole proprietorship or partnership, there is no protection from liability. 

If someone gets injured on your property or if you get sued for something unrelated to the business, then all of your personal assets could be at risk. This is where forming an LLC becomes beneficial because it protects all of the owners’ personal assets including their home and other investments like retirement accounts and cars.

The LLC provides a certain level of protection to its owners by limiting their personal liability – business debts are covered by the business, and lawsuits, liens, and other claims are shouldered by the business and its assets alone. 

Of course, if you commit an illegal act as an LLC owner, you are not protected – and an LLC doesn’t always protect you when it comes to acts of negligence, either. 

The most obvious benefit of creating an LLC is to protect your personal assets. Your liability will be limited to the assets and resources of the business itself. With an LLC, you can get all the liability protection you would get in a corporation – yet without the high cost that creating a corporation presents. 

Tax Purposes

Another reason why people choose to set up their companies as LLCs is to afford themselves a bit more flexibility at tax time. An LLC is not a distinct entity at tax time, which is different from a corporation. As an LLC owner, you’ll report your operating results, including whether you had a loss or a profit, on your personal income tax return -just as you would a partnership or sole proprietorship. 

While some people do file separate tax returns for their LLCs, it is not required. Your expenses and income will be reported on your individual income tax returns, either on Schedule C if you are a sole proprietor or Schedule E if you are a partnership. 

There is a significant tax benefit for creating an LLC, especially when compared to other business types, like a C corporation. In a C corporation, the IRS requires owners to first pay taxes on net income of the corporation before that income is distributed to the owner. After that income is distributed, it is taxed again – you’ll be taxed twice. This is something you can avoid with an LLC. 

Of course, let’s not forget one of the most tangible and immediate benefits of forming an LLC – it makes you seem more official! It is registered with the state and gives you so much street cred, if we do say so ourselves!

When To Form an LLC

When you decide to start a new business, you’ll have plenty of choices. If you can’t decide whether you should form an LLC or another kind of business, you’ll want to consider these tips.

Limited-Liability-Company-Businessman

1. If You Want to Have Limited Liability

When you have a sole proprietorship or partnership, you and your business are recognized as being the same person. The business debts are your debt, the business liability is your liability.

When you form an LLC, you’ll be responsible just for your own personal obligations and debt. Sure, you can lose some of the money you have invested in your company – but your bank account and home are safe from collections when it comes to business debts. The same goes for your personal assets, which are protected if the business or a partner is sued. 

2. Minimal Paperwork

Although there are certain steps you’ll have to follow when it comes time to form your LLC, creating an LLC generally requires far less paperwork than other kinds of businesses, including DBAs and corporations. 

Corporations offer the same protection in terms of liability that you will receive when you form an LLC, but you have to meet certain requirements that aren’t necessarily appropriate or helpful when running a small business. For example, as a corporation, partners must regularly hold annual shareholder meetings, make annual reports, and pay yearly fees to the state. 

As a corporation owner, you’ll be responsible for much more paperwork and recordkeeping than you would with an LLC. 

3. Tax Benefits

We’ve mentioned this before but it’s worth saying it again – as an LLC, you’ll receive far more tax benefits than you will with a sole proprietorship, S corporation, C corporation, or DBA. 

You’ll be able to take advantage of pass-through taxation, a process in which the LLC does not pay any corporate taxes or LLC taxes. Instead, your income and expenses will just pass through to your personal tax return. 

4. Flexibility

Starting an LLC offers additional levels of flexibility in creating and managing your business. For instance, an S corporation will enjoy the benefit of pass-through taxation, as listed above, but it can’t have more than 100 shareholders. LLCs enjoy the same taxation benefits but there aren’t any restrictions on the number and type of owners.

There also is not a fixed management structure. If you choose to start a corporation, there will be a required structure that includes a board of directors and officers who run the daily business. Owners must meet annually to elect directors. With an LLC, you’ll have much more flexibility in how you choose to structure your business.

There’s also added flexibility when it comes to profit distributions. You can choose how profits are shared amongst shareholders. 

How to Set Up an LLC: A Step-by-Step Guide

Has this article convinced you that creating an LLC is the way to go? If so, it’s time to get your LLC up and running! Follow these steps to set up your own LLC.

How-to-Set-Up-an-LLC-Select-A-Business-Name

1. Select a Business Name

First things first – you need to decide what you’re going to call your business (of course, only after you’ve already decided what your business is going to be – and specialize in!). 

You’ll have to accomplish two separate tasks when deciding what to name your business. First, you need to make sure that the name you choose doesn’t duplicate the name of an LLC that already exists. Don’t worry – your state will let you know whether your name is original or not.

Second, your name needs to comply with any regulations your state might have in regard to LLC. Usually, that means that the phrase “limited liability company” or “LLC” must appear somewhere in the business name. Some states have additional requirements on top of this.

Of course, it should be a name that you love and feel a strong attachment to, too! After all, it’s going to be around for a while.

2. Create and File Your Articles of Organization

Your next step is to create and file articles of organization. These vary a bit between states, but generally, it is going to be a basic document that forms your LLC.

If it sounds complicated and overwhelming, don’t worry – this is a process that is actually quite seamless. Your state likely has a standardized form that will let you plug in your information. It’s just like filling in the blanks! The only information you will have to provide here will have to do with your LLC’s name, your address, and the names of the owners. You (and sometimes the other owners of the LLC) will just have to sign the document before you file. 

You’ll have to pay some fees to file, too. Usually, this isn’t very much – sometimes it’s as little as $100 to $500. This depends on the state. 

3. Select a Registered Agent

Each LLC should have a registered agent – typically, this is one of the owners of the LLC. It could even be you! Don’t worry  – this responsibility is not an overwhelming one. As a registered agent, you’ll represent the LLC and be responsible for receiving any legal documents in the event of a lawsuit.

4. Publish a Notice of Intent

The next step in creating your LLC is to publish a notice of intent. Most states require that this be done in a local paper. If you aren’t sure what to write, that’s okay. Newspaper staff is usually trained in how to do this – they can help you write your notification. They may even have a template you can fill out.

Generally, this notice must be published repeatedly over the course of several weeks or months. You’ll have to file an affidavit of publication with your state as proof that this was done. 

While this is a requirement in just about every state, the downside of this requirement is that it can take a significant amount of time – so if you are trying to create your LLC quickly, the newspaper process can slow you down. 

5. Create and Publish an LLC Operating Agreement

Last but not least, you need to create an operating agreement. The good news is that this is the final step in your journey  – but the bad news is that it can take a significant amount of time.

An operating agreement isn’t technically required by the state – but it’s a good idea to have one on hand to avoid any issues later on. It can be a simple document and while it doesn’t necessarily need to be prepared by a lawyer, it can be helpful to have one help you draft this document up, particularly if your LLC has multiple owners..

You can often find detailed form requirements from state offices or via a general web search. That way, you’ll know exactly what to include when you write up this document. 

What is the Downside to an LLC? 

Of course, there are some disadvantages to starting an LLC, too – but for most people, the benefits far outweigh the negatives. 

For one, as an LLC owner, you cannot pay yourself wages. You may find that the renewal fees or publication requirements can be expensive and time-consuming, depending on the state, and many states charge franchise or capital values taxes on LLCs. 

Another potential issue that you may encounter is in finding investors – potential investors are far more likely to put money into a corporation instead of an LLC. This can make it more challenging to get your business up and running. 

Limited-Liability-Company-Downside

So is forming an LLC right for you? Only you can be the judge of that – but consider the pros and cons of creating this kind of business before you dive in. Starting a new business is an exciting venture, especially if you are aware of all of the financial and legal ramifications before you do so. 

Forming an LLC: FAQ

When deciding if, when, and how to form an LLC, there are a few common questions that may come up. Below are some questions you may have and answers to further your understanding.

When-To-Form-An-LLC-Frequently-Ask-Questions

Does an LLC need to make money? 

LLCs aren’t required to have income or profits. However, if you choose to claim tax deductions through your LLC at tax time and don’t report any income (or a loss), then you are far more likely to trigger an audit from the IRS when you file. 

Do LLCs get tax breaks?

An LLC can help you avoid double taxation, as long as you choose not to structure the business as a corporation. 

Can one person own an LLC?

Yes. A single-member LLC is simply a limited liability company with a single owner. 

Should I get an LLC before starting a business?

You don’t necessarily need an LLC to start a business, but for many people, the benefits of creating an LLC far outweigh the costs and hassle associated with setting one up. You’ll have a more formal business structure, more credibility, and of course, more tax benefits and liability protections. 

Should I form an LLC or sole proprietorship? 

A sole proprietorship is the easiest and simplest form of business to start up. It requires no legal filing, no drawing up of official documents, no lawyers – nothing. It can be the easiest way to get your business up and running. However, if you’ve had a business for quite some time and are interested in certain tax and liability protections, forming an LLC is a good idea.

<span style="font-size:12px;font-weight:500">Author</span><br><a href="https://wealthpursuits.com/author/kevin/" target="_self">Kevin</a>

Author
Kevin

Kevin is an ambitious entrepreneur that is obsessed with all things related to finance. From a young age, Kevin has always been involved with side hustles ranging from online selling to freelance work. Over the years, Kevin graduated from side hustles and started launching multiple online and offline businesses. Kevin is a serial entrepreneur who loves starting new businesses and exploring all things related to business and finance. He is constantly looking for new ways to save money, invest money, and create income streams.

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