Once you have decided to form a limited liability company or LLC, you need to choose a name. Almost any name will work so long as it is already being used or is deceptively similar to a name being used by another entity that is filed with the State Filing Office which is usually the Secretary of State's Office.
The name must end with the words Limited Liability Company or an abbreviation such as LLC or L.L.C. For example, you could have Jones Plumbing, Limited Liability Company or Jones Plumbing, LLC. The ending such as LLC or Inc is not considered part of the name when searching for availability.
STEP 2 - File Articles of Organization with State:
The first official step in forming an LLC is to file Articles of Organization (sometimes called a Certificate of Organization) with the State Filing Office and pay the required filing fee. Most people use the form provided by the State Filing Office and you can usually get one online.
Special Note: A lot of people stop at this point becuase they think this is the end of the process. However, that can be a costly mistake. To fully complete the organization of your LLC, you need to follow the rest of the steps outlined below. If you don't, then the limited liability protection provided by the LLC may be at risk.
Another Important Caution: All legal entities like an LLC are required to name a registered agent and list a registered address in the Articles of Organization. A registered agent is simply a person or incorporated company who can accept service of legal papers if your company is sued or the person who can receive mail from the State Filing Office. You can act as the registered agent for your LLC if you want but there are some situations when this is not advisable. You can read more about this by checking the links below.
STEP 3 - Prepare and Sign or Adopt an Operating Agreement:
Once the Articles of Organization have been filed, the organizers of the LLC should prepare and sign or adopt an Operating Agreement. Although not required by state law, The Operating Agreement is an essential document which sets forth the rights, duties and obligations of the members of the LLC, including who will manage the LLC and such other things as the division of profits and the distribution of income.
The Operating Agreement is an agreement between the parties involved in the LLC and helps to strengthen your limited liability protection by showing that you have completed the organization of the LLC and are in compliance with the process. It helps demonstrate that your LLC is being operated as a separate legal entity. This is true even though you may only have a one member LLC.
The State Filing Office usually will not provide Operating Agreements. This is something you have to do. You may find some samples online but you need to be careful with boilerplate agreements. You can find a form by checking the links below.
STEP 4 - Conduct Organizational Meeting and Prepare Minutes:
One of the benefits of an LLC is that there is no legal requirement for the LLC to hold meetings and prepare minutes of the meeting like required with corporations. However, it is still a wise business practice to document important business decisions. In addition, it helps demonstrate or prove that the LLC is being operated as a separate legal entity.
Even though there is no formal requirement, owners of an LLC should have some form of organizational meeting soon after the initial Articles of Organization are filed. Typically, minutes of such a meeting would include such items as the approval and ratification of the Articles of Organization and the Operating Agreement, a statement concerning who is managing the LLC and each Member's percentage of ownership in the LLC. You can learn more about what types of items should be included in minutes by checking the links below.
STEP 5 - Prepare Written Documentation of Ownership Interests in the LLC:
Most people know that a corporation is owned by the shareholders who each own a certain number of shares in the company. The terminology most commonly used to describe owners in an LLC is a Member and their ownership interest is referred to as a Membership Interest. A Membership Interest may consist of any number of units of the LLC. However, the most important concept is that Membership Interests are usually described as a percentage of the whole (which is 100%) or as a sharing ratio of the whole.
The most simple way to describe Membership Interests in an LLC is the sharing ratio. For example, if a certain member of the LLC owns of the LLC then the sharing ratio would be 50/100. If he/she owns then the sharing ratio would be 25/100. Sometimes Membership Interests are stated as a number of units similar to shares of stock.
It is important to document or put in writing a member's ownership interest in an LLC for several reasons. First, membership interests determine certain legal rights such as voting rights and may be important for making distributions of income. Obviously, if you have a one person LLC, this issue becomes less important.
With respect to liability issues, if you have not documented ownership of the LLC, then a question is raised as to whether you are really operating as a separate legal entity. In other words, a legal entity like a corporation or LLC cannot exist and function without owners. A second reason is to avoid disputes between owners and possible breakups due to disagreements over income, management rights, etc.
I have seen many disputes arise in smaller companies when one of the partners wanted to leave or sell his/her interest and the parties had never really documented what each of them owned or what each of them started with as far as an ownership interest. Memories tend to dim and people often have a different perspective as to what they have put in or contributed to the business.
STEP 6 - Obtain a New Employer ID# (EIN) from the IRS:
This is fairly self evident but each separate legal entity requires a new or different federal tax identification number (EIN) from the Internal Revenue Service (IRS). This is true because the entity is considered separate and apart under the law from the individual owners. The exception to this with LLC's is when you have a one person LLC. When an LLC is owned and operated by just one person, that person has the option of reporting taxes on his/her own social security number or obtaining a new EIN #. If a new EIN# is required then you need to file form SS-4 with the IRS. You can do this online by checking the links below.
STEP 7 - Start A Separate Bank Account for the LLC:
This is essential. A lot of people I work with wonder why they can't just continue using the same bank account they used before for the business when they were a sole proprietor or partner. Again, the principle behind liability protection is that the LLC is a legal entity, separate and apart from the individual owners. A separate legal entity requires a separate bank account.
If your business is ever sued, one of the important issues a court looks at in deciding questions of liability is whether the LLC owners have co-mingled their personal and business funds and assets. In other words, do the owners pay for personal expenses out of the LLC bank account or visa versa. Obviously, if you are using the same bank account for your LLC and personal needs, then you will be co-mingling the funds. Another issue involves the use of LLC property for your personal use which is also a form of co-mingling.
The use of a separate bank account and the paying of LLC bills only from that bank account and the paying of personal bills from a separate personal bank account helps prove or establish the existence and operation of your LLC as a separate legal entity.
FINAL COMMENTS:
If you organize and operate your LLC properly, you are entitled to limited liability protection, which provides a shield between business debts or obligations and your personal assets. This is because the LLC is a legal entity separate and apart from its owners. If a legal action is brought against you, you need to be able to prove or demonstrate that you have operated the LLC as a separate legal entity. Since each case is decided on the individual facts unique to that case, there is no way to guarantee that a person will have the liability protection of an LLC. However, if you follow the steps outlined above, you put yourself in a much stronger position to insure the liability protection you want and deserve from your LLC.
If you form an LLC in a state that is different from the one you are conducting most of your business in, you will likely be required to file an application as a foreign LLC or foreign corporation (meaning from another state) in any other state where you conduct substantial business or have substantial business contacts.
For example, if you form an LLC in Nevada but your business office is in Oregon and you do most of your business in Oregon, you will have to file and pay fees in Oregon as a foreign LLC doing business in Oregon, in addition to filing and paying fees in Nevada.
This dual filing is expensive and may result in substantially more record keeping which may outweigh any potential advantages. Some larger LLC's and corporations are registered as foreign entities in every state but this is expensive and time consuming for most small businesses.
In some cases, there may be a valid reason for setting up an LLC or corporation in a state different than where you conduct business. There may be some special tax advantages or liability advantages in one state which are helpful to your special type of business. This requires some advanced research into the tax and liability laws of the state you want to use. Give your accountant or tax advisor a call and discuss this with them.
Many people believe that Delaware and Nevada are the best places to set up a new LLC or corporation. In my experience this is not necessarily true. Delaware may be a good state for larger companies but the costs and red tape of foreign state filings likely outweigh the advantages for smaller businesses. The same is true of Nevada.
For example, Nevada boasts no state income tax on corporations or LLC's. However, LLC's don't pay income tax anyway. They are considered pass through entities which means the LLC itself is not subject to federal or state income tax. Rather, the owners or members pay income tax on their pro rata share of the income. If you live and do business in a different state, you will likely have to pay income tax in that state.
It is true that in some states the members will have to pay state income tax on their share of income from an LLC. There are other states which do not have state income tax but they often make up for the revenue with some other form of tax or assessment.
Nevada also boasts that it protects privacy because they do not share information with the IRS. Believe me, if the IRS wants information or records from a business, all they have to do is issue a subpoena and they get the information. I've seen it done. In addition, if you form a corporation in Nevada but then have to file as a foreign corporation or LLC in another state because you do business there, your information will be shared with the IRS anyway.
I believe in being in being aggressive about reducing taxes and saving money but I also believe in doing it honestly. If you are running a legitimate business and are properly filing tax returns, why should you be so intent on not having your information shared with the IRS anyway.
If your business provides services or products in many places, such as an internet based business, then you have more choices. However, even with an internet business, if you do substantial business in any particular state, you may still be required to register in that state as a foreign corporation or LLC.
The bottom line is that for most smaller businesses, forming an LLC or corporation in your home state or in the state where you have the most business contacts or where you do most of your business is still the best practice and will likely save you some money.
Both Robert Montgomery & Bob Montgomery are contributors for EditorialToday. The above articles have been edited for relevancy and timeliness. All write-ups, reviews, tips and guides published by EditorialToday.com and its partners or affiliates are for informational purposes only. They should not be used for any legal or any other type of advice. We do not endorse any author, contributor, writer or article posted by our team.
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