As an entrepreneur willing to set up a limited liability company as your plausible business structure, there are some crucial factors to note. You should be aware of the key issues related to starting an LLC and that’s what we will discuss today.
A Limited Liability Company (LLC) is a business structure in the US whose owners are not legally responsible for the company’s debts. It designates your business as a separate legal entity. It combines both the benefits of a corporation and partnership business structures.
An LLC protects your personal assets in case of lawsuits or bankruptcy. It is usually the most adopted legal structure by small business owners due to its various benefits such as flexibility.
However, below are factors to consider before you choose a limited liability company:
- The State for Your LLC
- The Name for the LLC
- The Required Business Licenses
- Your Company Type and Structure
- The Right Tax Option for Your LLC
1. The State for Your LLC
Since they are based on state laws, the location of your LLC should be your first consideration.
Many businesses choose Delaware because it has a well-developed law structure. As a rule of thumb, you should form the LLC in the state where the business will be operated.
2. The Name for the LLC
The next step is to choose a suitable name for your Limited Liability Company . It has a naming convention and rules to follow. For instance, the business name should end with “LLC.”
Also, it can’t contain words that are forbidden by the state, such as “bank”, “trustee” etc. There are so many other naming rules; you should check them out.
3. The Required Business Licenses
This depends on the nature of your business. You may either require a local, state or federal license depending on the nature of the business you run. For instance, a firearms seller needs a state, federal, and/or business license.
4. Your Company Type and Structure
Since Limited Liability Companies are easy to run and are flexible, they are more preferred by businesses with medium to high risk.
A common feature of an LLC is that the owners are usually self-employed or they run small businesses. Record keeping and tax filing are usually less tedious when running a Limited Liability Company.
An LLC is usually suitable for businesses with quite a high level of uncertainty or future hazards where owners are held liable. It offers a form of protection for you and your family in case the company incurs debts or faces lawsuits.
However, a business owner who plans to raise funds in the future through external investors shouldn’t consider running an LLC. They are not public structures and have no shareholders, so there is no option of conducting an initial public offering (IPO).
5. The Right Tax Option for Your LLC
In a Limited liability company, you can decide how you want to be taxed and this requires careful thoughts. Since they are a product of state statute, LLCs enjoy a great deal of flexibility for federal tax treatment.
A single-member LLC can either choose to be taxed as a sole proprietorship or corporation (either a C corporation or S corporation). On the other hand, a multi-member LLC can decide to be taxed as a C corporation or S corporation or partnership.
While tax flexibility is a great feature for your business, you have to know which one is best for you. You also have to understand the features of each federal tax classification structure.
Let’s consider the four options for a Limited Liability Company taxation structure:
A. Sole Proprietorship
You could choose your LLC to be structured as a sole proprietorship. This means that you have to be the sole owner of the company. This classification is treated as a “disregarded entity” by the IRS. This business entity does not file any tax forms and therefore, you report business income or loss on your personal tax forms.
In summary, the Limited Liability Company is taxed similarly to the business owner. This means that the LLC’s activities are reported by the owner on Schedule C of their personal tax return. For an LLC that makes income from an active business selling goods or rendering services, you pay self-employment taxes.
However, if it is a passive business like real estate, you are not required to pay self-employment tax on the profits. You file your passive profits on Schedule E instead.
An LLC that has more than one member is taxed as a partnership. Like sole proprietorship, the taxes incurred in a multi-member LLC are passed down to the partners in the business. The partnership LLC files its business income on form 1065 indicating the total profits and losses.
Similar to the single-member LLC, the business doesn’t have to pay self-employment taxes if it is involved in a passive activity. However, the opposite is true for an active business.
C. C Corporation
If you choose to file as a corporation for tax purposes, you will need to file Form 8832 with the IRS. One advantage is that the LLC will be taxed as a separate entity. This means that the taxes are not passed directly through the personal taxes of the business owners.
In this business structure, the owner’s personal and business assets are treated separately. Therefore, the business can benefit from the tax deduction. Profits from the LLC filed as a C Corporation are not subject to self-employment taxes.
However, one disadvantage of filing an LLC as a C Corporation is the issue of double taxation. This means that you and the other owners will file personal income taxes and also file an income tax return for the business.
D. S Corporation
You can also file an LLC as an S Corporation for tax purposes. Doing this, all the individual owners are taxed on their respective shares of the company’s profits. Also, an S Corporation (LLC) is not required to pay tax on its profits.
The owners of the S Corporation LLC can report profits and losses of the LLC on their personal tax returns. This way, they can avoid double taxation. The LLC does not pay income tax on the profits.
Forming an LLC has some amazing features that make it sought after by small businesses. However, you have to do your due diligence before you set up your LLC.
About the Autor: Entrepreneur and Online Marketing Consultant, Joseph Chukwube is the CEO at Digitage.net and the Founder and Editor-in-chief at Startup Growth Guide. Reach out to Joseph to get expert support in growing your business online.
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