If you currently work for yourself, chances are you’re a sole proprietor.

The members of an LLC can choose whether the business will be member-managed or manager-managed.

But if you want to protect your personal assets from potential legal action against your business or plan to expand, you should consider forming a limited liability company (LLC).  In this article, we’ll cover some key characteristics of LLCs and provide step-by-step instructions for organizing one.

What Is an LLC?

An LLC is a type of business structure authorized by statute in all 50 states. It’s not a corporation – instead, it’s described as a hybrid entity that combines certain features of a corporation and a sole proprietorship or general partnership. As such, it’s often considered a simplified solution for smaller enterprises looking for a layer of personal asset protection, a choice of tax systems, and the ability to grow.

Purpose

Most types of businesses can organize as an LLC, except for financial institutions and insurance companies. In some states, certain licensed professionals like doctors, lawyers, and architects are required to form a similar entity called a professional limited liability company (PLLC). Generally, LLCs must register in the state or states where they are conducting business, and special rules may apply to so-called foreign LLCs, which include LLCs doing business out of state, not just internationally.

Ownership

The owners of an LLC are called members, and in most states, there’s no minimum or maximum number. Single-member LLCs are quite common, and LLCs with hundreds of members are rare but not unheard of. Members don’t need to be individuals – they can also be corporations, trusts, estates, or other business entities. Members do not have to be U.S.-based. Membership interest in an LLC may be transferred to other parties.

Operations

LLCs are separate legal entities, so they’re subject to state compliance and licensing requirements. But compared to a corporation, these requirements are pretty minimal: You don’t have to appoint a board of directors, adopt bylaws, or hold shareholder meetings. You do have to maintain a registered agent (someone who can handle legal papers on behalf of the LLC), and depending on your state, you may have to submit a short annual or biennial statement along with a filing fee.

Management

The members of an LLC can choose whether the business will be member-managed or manager-managed. In a member-managed LLC, all the members participate in running the business, much like a general partnership. In a manager-managed LLC, one or more members – or even one or more nonmembers – are given day-to-day decision-making authority while others remain passive investors.

For example, in the case of a three-member LLC, the business could be managed by three, two, one, or none of the members, depending on the specific needs and goals of the enterprise. Regardless of whether your state requires you to spell out your management structure in your articles of organization, it’s always wise to put your plan in writing, especially if multiple operators or investors are involved.

Liability

As the name suggests, LLCs are most notable for the legal protections they provide to their members. Normally, the members of an LLC are not held personally responsible for the business’s debts or legal judgments or for the actions of other members. That means that creditors and courts can only pursue assets held by the LLC, not anyone’s homes or personal accounts.

A few important caveats apply. If LLC members commingle personal and business funds or fail to maintain proper records, courts may “pierce the corporate veil” and hold members personally liable. Limited liability also doesn’t extend to personal loan guarantees, failure to withhold and deposit payroll taxes, or certain torts (negligent or intentionally harmful acts). Consult your attorney for details.

Taxation

As Benjamin Franklin famously said, “Nothing is certain except death and taxes,” but with an LLC, you can choose how you’re taxed. By default, LLCs are treated as pass-through entities, meaning income is reported on members’ individual tax returns and taxed at their usual rates. This keeps paperwork to a minimum and avoids the double taxation that happens when income from regular corporations is taxed once at the entity level and again when it’s distributed to shareholders.

However, corporate tax structures can provide certain other advantages, and eligible LLCs can elect to be taxed as either regular C corporations or S corporations. In many cases, forming an LLC and being taxed as an S corporation is a best-of- both-worlds scenario because you can avoid double taxation while saving on self-employment taxes. But like everything in business and life, the circumstances are not one size fits all, and it’s always a good idea to consult an accountant.

How to Form an LLC

The exact protocol for organizing an LLC varies by state, but the basic steps are:

1. Pick a name. Conduct a name search to avoid trademark issues, and ensure that the name follows state-specific naming requirements.
2. Assign a registered agent. In some states, you can be your own registered agent; in others, you have to designate another person or entity.
3. File your articles of organization. Prepare and submit the required documents to your secretary of state and pay the filing fee.
4. Develop an operating agreement. This is where you define members’ roles, distribution of profits and losses, and procedures for dissolution.
5. Obtain an employee identification number (EIN). This acts like a Social Security number for your LLC and enables you to establish a business credit profile.
6. Secure licenses and permits. Be sure to comply with all applicable local, state, and federal requirements as well as industry best practices.
7. See if publication is required. A few states mandate that you place a notice in a local newspaper announcing the formation of your LLC.
8. Open a business bank account. It’s essential to keep your business and personal funds separate. Consider a dedicated business credit card, too.
9. Consult the professionals. Seek advice from legal and financial experts to ensure your business structure is set up to maximum advantage.
10. Stay informed and compliant. Keep track of ongoing filing responsibilities, regulatory changes, and industry expectations to maintain good standing.

Let’s Work Together

For more individualized guidance on how to set your small business up for success, consult your financial advisor.

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