The pandemic dramatically altered the professional landscape. Many of us went remote. Some of us are staying that way for the near future. There were layoffs, along with people reevaluating whether or not they wanted to work for someone else. If you’re going into business for yourself, you’ll need to decide which business entity to choose. There are many structures to choose from. Previously, we discussed Sole Proprietorship, General Partnership and Limited Partnership and Limited Liability Partnership. The most common form of business entity (and most popular with start ups) is a Limited Liability Company (LLC). Rules and regulations vary by state, so for the purposes of this article, we are discussing setting up an LLC in New York State.
The Definition of a Limited Liability Company
Owners of an LLC are called members vs. a corporation which has shareholders and a partnership which has partners. Most states, including New York, don’t restrict ownership. This means that members may include individuals, corporations, other LLC’s and foreign entities. There is no limit to the number of members. You can even form a single-member LLC. An LLC combines some of the benefits of a corporate structure (including protection of your personal assets) with those of a partnership. Owners can decide how profits are distributed and how management allocates profits and losses.
The Advantages and Disadvantages of a Limited Liability Company
A Limited Liability Company has its pros and cons. It’s best to know up front what you’re in for, though you can change your business entity at any time if you decide that another entity would be a better fit as your company evolves and expands.
Advantages of an LLC
- This is considered a hybrid business entity. By default, a multi-member LLC is taxed as a partnership and a single member LLC is taxed as a sole proprietorship. However, you can make an election to be taxed as a corporation.
- Similar to a corporation, an LLC is considered a separate legal entity. This shields the members from liability for the debts or legal actions as long as it maintains a formal legal separation between business and owners personal financial affairs.
- An LLC is easier to set up as compared to the formation of other type of entities so that you may not need a lawyer to set it up and relatively inexpensive (costs varies on the states).
- You can decide how profits and losses are distributed with an operating agreement as long as the LLC is taxed as a partnership.
- Only the members of the LLC are taxed. The LLC is not taxed although some local taxes such as NYC Unincorporated Business Taxes may apply.
- LLC’s with more than one member may be member-managed or manager-managed.
- You can enter into contracts, open a bank account, hire employees, get business permits and licenses in the name of the LLC.
Disadvantages of an LLC
- This business structure cannot be used by banks or insurance companies.
- If your company is looking for venture capital, investors might require that you switch to a corporation.
- The LLC could be dissolved if one of the partners leaves or dies and no succession plan is placed in the operating agreement.
- Self-employment taxes apply to all business profits, unless the LLC designates that it wants to be taxed as a corporation.
- You cannot issue stock to raise capital for the business. However, similar to a Limited Partnership, members of an LLC can be investors only and have no participation in the day-to-day business as long as it is stated in the operating agreement.
- If you plan to do business in more than one state, you may be required to register in each state, filing a notice with each Secretary of State and paying the filing fees.
- You might be prohibited from using some terms in the name of your LLC, including corporation, inc., incorporated, or corp.
- Members of an LLC being taxed as a Partnership or single member LLC are technically not allowed to take payroll and be taxed similarly to an employee.
How to Form a Limited Liability Company
One of the first steps is to do the research to ensure that the name of your business is available. The business name must end with LLC. You will also need to do a trademark search. You can select a separate name to do business as (DBA). If so, you may be required to file a “fictitious business name” statement or “doing business statement.”
The next step is to file Articles of Organization with the Secretary of State. You don’t need to form your LLC in the state that you operate. However, if you formed an LLC in a state other than your home state, you will have in register to your home state where your business operates.. In addition, depending on the state, you may need to file a Certificate of Publication. In New York State, within 120 days after the filing of the Article of Organization, the business must publish in 2 newspapers a copy of the article or a notice related to the formation of the LLC and submit a Certificate of Publication. Finally, you’ll need an Employer Identification Number (EIN).
We also recommend that you create an operating agreement that clearly outlines how the company will be run and what each member can and cannot do when making business decisions. For example, the agreement will outline who will handle the day-to-day management of the company or if another person will be designated as the manager.
How Does an LLC be Taxed?
It all depends on how you want your LLC to be taxed. By default, multi-member LLCs are treated as a pass-through entity, like a partnership. Similarly, the LLCs elected to be taxed as S corporation are also treated as a pass-through entity, where LLC’s income and losses pass through to the members’ personal income tax return and are taxed at member’s personal income tax rate. Single-member LLCs are taxed as a sole proprietorship and income and losses are reported on the member’s Schedule C of Form 1040 and taxed at the member’s personal income tax rate. For LLCs who elect to be taxed as a C corporation, the corporation will be taxed at the business level. The members will not be taxed on the LLC’s earnings and profits, but will be taxed on the dividends received. Because of these flexible options to be taxed by LLCs, we will not discuss specific forms and other tax issues on this article. Please refer to our previously released articles about Sole Proprietorship, General Partnership, Limited Partnership, and Limited Liability Partnership, and forthcoming articles about S and C corporations for specific forms and other tax issues.
If you have any questions about whether an LLC is the right entity for your business, or about the requirements, please contact us. As with all major decisions, it’s best to speak with your accountant prior to deciding which business structure is the best fit.