Business Entities: Limited Liability Company
You’ve decided to start a business. Now What?
If you have already made the big decision to open a business, the first legal issue you must resolve is what type of business entity you want to form. There are several different business entity forms to choose from, ranging from a simple sole proprietorship to more complex corporate structures. The decision as to which business entity to choose is based on a number of factors that will be unique to your business and its particular goals, and can determine the success of your business. That said, an increasingly popular form of business ownership in Washington is the Limited Liability Corporation, or LLC.
What’s the big deal about LLCs?
An LLC lies in the middle of a continuum between a corporation and a partnership/sole proprietorship. Like a corporation, an LLC protects owners from personal liability for business debts. But like a partnership, an LLC is a pass-through tax entity. The LLC doesn’t pay the taxes, the taxes pass through to an LLC’s owners, who report them on their personal tax returns. Running an LLC is a lot less complex than running a corporation, but requires additional steps to form. The owners of an LLC are usually known as “members.”
I like limited liability, but what are the drawbacks?
You probably already know that limited liability means a business creditor can’t come after an owner’s personal assets to satisfy a debt. Limited liability may be a major selling point for an LLC. But this benefit isn’t unique to LLCs; C-Corporations and S-Corporations have limited liability as well.
Generally, you will receive the benefits of limited liability so long as you adequately fund your LLC from the outset, don’t mix the LLC with your personal business and don’t commit crimes or personally injure people in connection with your business. You need to also make sure that the public knows that your business is an LLC, and your signs, contracts, and business cards should identify it as such. The idea here is to put everybody on notice before they hire you or patronize your business that your liability is limited. If you are concerned about possible exposure in spite of limited liability, you may also want to obtain a good liability insurance policy to shield your personal assets in case limited liability does not extend to a particular debt.
So does opting for limited liability mean that I have to pay more taxes?
The LLC taxing structure is part of why this particular form is gaining popularity. When you form a corporation, you subject yourself to double taxation and excessive paperwork. This extra work can complicate your life if you want to receive an optimal tax rate. However, double taxation can be avoided by forming an LLC.
Unlike a corporation, an LLC is not considered separate from its owners for tax purposes. Instead, it is what the IRS calls a “pass-through entity,” like a partnership or sole proprietorship. This means that business income passes through the business to the members. The members in turn report their share of profits, or losses, on their individual income tax returns.
While an LLC doesn’t pay taxes, co-owned LLCs must file Form 1065, an informational return, with the IRS each year. This form, which partnerships also have to file, sets out eachLLC member’s share of the LLC’s profits (or losses), which the IRS reviews to make sureLLC members are correctly reporting their income.
How will the organization be structured?
Limited Liability Companies are flexible. In large part, you get to decide how the company will be run on a day to day basis. But you need to make sure and have an operating agreement which will define each member or manager’s rights, entitlements and duties. This document created by the owners is an agreement that contains provisions for critical items and rules that run the company. It is a lawyer’s job to understand what particular terms your type of business needs and how to include those terms in an operating agreement.
So an LLC is right for your business? Now what?
The creation of an LLC is relatively simple. The prospective owners fill out a one page “Articles of Formation” form available from the Washington Secretary of State. You must also pay a filing fee of approximately $200.00. In roughly a week, your LLC will legally exist – but you are still not necessarily be ready to hit the ground running. You are still going to need an operating agreement. This agreement will define, organize and direct your business. This is an important opportunity to individualize the business structure and avoid the default rules that will apply to your business in the absence of an agreement. While not required by Washington state law, it is a good idea to have a lawyer draft up an agreement that clearly defines the owners’ financial and managerial rights and duties. A few hundred dollars spent on drafting an individualized operating agreement can be invaluable in understanding how the business will operate and can help to avoid and resolve future disputes among owners. Also, -have you already adopted an agreement you don’t like? It’s never too late; an operating agreement can usually be amended at any time.
If you are considering opening a business and want to discuss which business form is right for you, please feel free to give us a call.