Taking the decision to start a new business is not an easy task. It needs painstaking research along with vigorous energy and vigilant decision-making, yet, it is very exciting and interesting. One has to address many questions related to why, where, when, which and what to a start business. Categorically, this needs a comprehensive knowledge of the market, financial-legal status, and many other socio-economic factors.
However, the decision to choose a business organization when starting a business is the most important and critical one. It is better to take the advice of a financial analyst while starting a new business to understand in depth about S-Corporation, Partnerships, Proprietorship and Limited Liability Companies. However, LLC has become the most popular business form for not only new entities but also for many existing entities.
Let’s go profoundly to understand what LLC is and how to get LLC?
What is LLC?
A limited liability company (LLC) is a corporate structure with a flexible business setup, which protects the personal assets of members of the company from being at risk.
Limited liability companies are fundamentally hybrid entities that syndicate the characteristics of a corporation and a partnership or sole proprietorship. People who owned it are known as its members. It can be single owner LLC or multi-member LLC. Usually, an LLC is managed by its members and in some cases; members will appoint a manager to handle the LLC’s daily operations.
Furthermore, for federal tax purposes, it must be treated as a partnership or corporation
Types of LLC
Limited liability and pass-through taxation are the two common factors that make all the types of LLCs alike but some specific business setups segregate them into the following types:
- Domestic LLC
- Foreign LLC
- Professional LLC
- Series LLC
When LLC is conducting business in the state in which it was formed it is referred as domestic LLC.
On the contrary, when an existing LLC decides to open offices or have any other kind of physical presence in a new state, it needs to register in that state as a foreign LLC.
As far as professional LLC is concerned, it is formed when professional service is required. To form a Professional LLC, it is necessary for certain members of the LLC to possess the necessary state licenses to demonstrate their professional qualifications.
Series LLC is a unique type of LLC is in which the parent LLC provides limited liability protection across a series of “child” businesses. Presently you can only form a Series LLC in Texas and sixteen other states: Alabama, Delaware, Washington D.C., Illinois, Indiana, Iowa, Kansas, Minnesota, Missouri, Montana, Nevada, North Dakota, Oklahoma, Tennessee, Utah, and Wisconsin.
How to Form an LLC
In order to start an LLC you just need to follow some simple steps:
- Pick a business name which is available and fulfills your state’s LLC rules.
- Complete formal paperwork and file it by paying filing fees
- Sets out the rights and responsibilities of the LLC members in the form of an LLC operation agreement
- Publish a notice of your intent to form an LLC (required in only a few states).
- Obtain licenses and permits that may be required for your business.
Factors That Make LLC the First Choice to Start a Business:
Limited Personal Liability
LLC provides protection to all owners from personal liability, means in case of insolvency of business creditors cannot legally claim their payments from any personal possessions of the owners. Business debts are paid by the assets of the LLC. Resultantly, owners of LLC have to bear the loss of their investment.
It has flexibility for federal tax treatment on account of its creation by state statute. LLC can be either taxed as sole proprietorship or a corporation and partnership or a C corporation or an S corporation, depends on whether it is single membered LLC or multi-membered LLC. Hence, its taxation can be done in the following four ways:
1. Taxation of Single-member LLC
A single-member LLC is basically taxed as a sole proprietor. This classification falls into the “pass-through” taxation category—the business doesn’t file any LLC tax forms. Owners of LLC report their business income and loss on their personal tax form.
Self-employment taxes are to be paid by the owners in case of an active trade or business, such as providing a service like copywriting or selling a product. But in case of passive activity, such as real estate investment, then owners don’t pay self-employment tax on the profits.
2. Multiple-member LLC as a Partnership
In case of a multi-member LLC, it will be taxed federally as a partnership, unless it elects to be taxed as an S corp or C corp. A multi-member LLC taxed as a partnership reports its business income on a separate 1065 partnership tax return. Then, each partner pays self-employment taxes on his share of the partnership profit on the Schedule SE tax form.
3. LLC as a C Corporation
It can be treated as a corporation for tax purposes by filing LLC tax Form 8832 with the IRS. The LLC files a corporate tax return 1120. It pays taxes on its profits at its corporate tax rate. With subject to profit distribution as dividends, those dividends are taxed again at the qualifying dividend rate (this is what’s known as double taxation). The LLC profits are not subject to self-employment taxes. But an LLC treated as a C Corporation is responsible for payroll taxes on any wages paid to LLC members who work for the business.
4. LLC as an S Corporation
In this last scenario, the LLC can be treated as an S corporation. The S corporation files a 1120S tax return, but the company’s profits are not subject to corporate income tax, as they are in the C Corporation. Instead, individual LLC owners are taxed on their respective shares of the company’s profits (and profits are not subject to self-employment tax). If an LLC owner works in the business, he must be paid a reasonable wage for his activities, and the LLC must pay payroll taxes on these wages.
Basically, LLC has two kinds of arrangements: member-managed or manager-managed. In member-managed LLC, owners participate equally in the management of their business while on the other hand in manager-managed LLC, LLC can be either managed by the group of managing members or owners hire a third party to manage it. In a manager-managed LLC, only the named managers get to vote on management decisions and act as agents of the LLC.
Why LLC is More Favorable Than S-corporations
LLCs can choose partnership tax status and have a tax advantage as compared to S-corps. LLC can allocate tax attributes, like income or certain kinds of income, depreciation deductions, etc., disproportionately among members to suit their individual tax situations (unlike S-corps limited by the effect of the single class of stock rule). S-corp owners can deduct startup or operating losses from investment while on the other hand LLC members can do the same but can deduct further, up to their share of the debt the LLC owes others. The addition of co-owners is a bit easier in LLC but difficult in case of S-corps. Distribution of appreciated LLC property to LLC members is not taxable while it is taxable in S-corporation
LLC is Preferred Over Partnerships and Proprietorships
LLCs, with their limited liability preferred over partnership and proprietorship from the business point of view. While the federal tax treatment of partners and LLC members are basically the same with some infrequent special tax rules for limited partners. In a proprietorship, proprietors are subject to direct taxation under federal tax rule as compared to LLC taxation.
Do Your Homework!
Choosing the right business form to start a new business is not a piece of cake. You need to be active, intelligent and a master of market opportunities. Moreover, the financial and legal aspects should be thoroughly discussed with legal and financial advisors. LLC is considered as the best option to start a new business as it provides maximum protection to the owners in the form of limited liabilities. Furthermore, flexible taxation is another factor which makes it advantageous.