Business Quick-Tips

Monday, March 8, 2010

When to Form an LLC

So you’ve been in “business” for quite some time now, whether it is online, out of your bedroom, from your car, garage, or maybe even a leased office space. You’ve made your money (or lost some) and are wondering what you can to do become even more legit as a business. Not to mention, you start to worry about some of the tax implications of running your own business.

Speaking from experience, forming that first LLC is one of the best moments in an entrepreneur’s life. It provides legitimacy as a business owner and provides a great sense of accomplishment. Of course, anyone for any reason can form an LLC, but what you might be wondering is, “when it is actually time for my small business to form an LLC?”

What is an LLC?

An LLC actually combines the small business friendly aspects of partnerships and corporations, so an LLC is less formal and more flexible than a typical corporation, yet offers protection as well as certain advantages that are much the same. For example, members cannot be found personally liable for company debts. Their assets are separate from the assets of the LLC so they cannot be seized. Flow-through taxation makes LLC’s a valuable business tool, allowing owners to be taxed only once instead of both as a business and as an individual on any salary paid out.

Pro’s of an LLC

• The LLC was specifically designed for small businesses, making it an intuitive aid in helping small business grow.
• Adds legitimacy to small business.
• Allows flow-through taxation; only pay taxes on earnings once.
• Allows business expenses to be directly associated to the business, making it easier to write off on your annual taxes.
• Provides liability protection for personal assets from lawsuit judgments and business debts.
• Relatively inexpensive (About $100-$300, some higher, depending on the state)
• Creates an Employer Identification Number (EIN) so that your business can hire employees or freelancers and write off their wages as company expenses.
• No required board meetings or administration of company meeting minutes.
• An LLC allows you access to business credit lines, discounted business rates, business clubs, memberships, and a whole host of other beneficial programs that are inaccessible to the non-LLC business person.

Con’s of an LLC

• LLC’s cannot be taken public. However, if you get to the point where your business is large enough to sell, you will probably be talking to attorneys and accountants who can better assist you in that transaction. LLC’s do not make it impossible for your business to be taken public; it’s just that LLC’s cannot be public companies.
• Some states, like California, do not let professionals (doctors, lawyers, accountants) use LLC’s.
• Each member's pro-rated share of profits represents taxable income, even if the profit is re-invested into the company.
• The managing member's share of the bottom-line profit of the LLC is considered earned income, and therefore is subject to self-employment tax.

Setting up an LLC

To set up an LLC, Articles of Organization must be filed according to state specific guidelines, and any and all fees must be paid. Articles of Organization are usually filed with the Secretary of State. You may wish to hire an attorney, although, unless you have a large small business it is highly unnecessary. Do you wonder if you business is large? Do you run it from home? If yes, then it probably isn’t large enough to warrant any attorney assistance. Plus, articles of organization can be modified later if needed.

You can apply for an LLC 100% online usually through your states department of commerce. I would simply do a Google search for “(State) LLC registration.” Here is what the Wisconsin LLC registration website looks like. Pretty straightforward.

So… What’s the Bottom Line? Should I form an LLC?

If you only have residual sources of income, it might not be necessary to have an LLC, after all, you can just record your income on the 1040 as “Other Gains” (Line 14). If you have income from a variety of sources as well as expenses (like postage, computer costs, freelance help), then the LLC is probably a good idea. If you have neither income nor expenses, but would like to add some legitimacy to your fledgling business, then the LLC is also a good idea.

*It is highly recommended that individuals seek assistance from qualified legal or tax representation when considering the advantages and disadvantages of LLC formation, as each business operates and performs differently.

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