“I will definitely state that if you have two or more business owners involved, that a competent local business lawyer should be involved in creating your LLC, and in drafting your related legal documents.”
A “Limited Liability Company” (LLC) is one of the most popular types of business entities in the United States today. The LLC concept, or something quite similar, has also become popular in many foreign countries.
The LLC entity type can be used when a “for-profit” business is being formed, and in many states, it can also be used for tax exempt organizations. Some states have a special type of LLC for professional practices. In Florida, where I live and work, professional practices must be organized as a “Professional Limited Liability Company” (PLLC) if the LLC format is desired.
Even with all of the popularity of the LLC entity type, and its rather long history (since 1982 in Florida), I still witness, on a regular basis, confusion among small business owners and even professional advisors over the legal nature and taxation rules for LLCs.
First of all, it must be understood that an LLC is a creation of state law. The laws of the state where an LLC is being formed will control many important aspects of its formation, subsequent ownership, and operations. You do not go to the IRS to form an LLC.
So, every state has its own LLC laws, related to formation and taxation, and you need to know these laws before you move forward with your decision on using an LLC. I have observed a lot of commonality in state LLC laws, but there are also some important differences from one state to another.
My own State of Florida CPA firm was formed as an LLC, actually a PLLC as mentioned earlier, in January 2010. I used a popular online legal services provider, and paid less than $400 for the entire process. Now, I want to emphasize here that I am a solo practitioner. This is an important point. I work alone, with no other owners involved.
I am not going to go on the record as saying that you can always safely create your own LLC if you are a one-owner business. You may be possibly facing other business risks and complications that were not a part of my own LLC startup.
I will definitely state that if you have two or more business owners involved, that a competent local business lawyer should be involved in creating your LLC, and in drafting your related legal documents. Do not foolishly try to save money on legal fees at this important point in your new business startup.
I had a former small business client with two owners. They formed their own LLC without any legal advice, and without any consideration at all of how the departure of one of the owners would be handled if that ever occurred. It was a total legal and financial mess, and I am very glad that I only became their CPA years after their LLC formation and business startup. I would not want to be at all responsible for the food fight that occurred.
So, with those precautions behind us, I wanted to just briefly summarize the non-tax aspects of the LLC entity. LLCs basically afford the business owner many of the same protections that come with a Corporation, but with fewer annual legal formalities. This is another area where you need to know the laws of the state where your LLC is formed!
Most Corporations have Stockholders, Corporate Officers, and a Board of Directors, each with their one state law requirements for periodic meetings and documentation, often referred to as Meeting Minutes. They also need Articles of Incorporation, and Corporate Bylaws. An omission of any of these legal formalities can lead to the loss of corporate protection in the event of a lawsuit against the business. Not good news.
An LLC has Members, and an Operating Agreement. Possibly, and most likely, the LLC has none of the other required procedures that I just listed above for Corporations. It is this operating simplicity, combined with liability protection comparable to a Corporation, that has led to the rise in popularity of LLCs.
Now let’s take a look at the IRS and state income taxation of LLCs. The automatic IRS income tax status of a Single Member LLC (one owner) is that the annual financial results are reported on IRS Form 1040 — Schedule C, just like an unincorporated Sole Proprietor. That simple.
The automatic IRS income tax status for an LLC with two or more owners, is that the LLC will be treated as a Partnership, and will file IRS Form 1065. That simple.
States have their own rules for the taxation of LLC business entities. Some follow the IRS reporting structure and some state tax rules are quite different. I have a small business client in California that must pay an $800 fee each year, even when their LLC has a net loss for that tax year. Ouch!
It is also possible for a Single Member LLC, or a Multiple Member LLC, to elect to be treated as a Subchapter S Corporation for IRS income tax purposes. That is accomplished by filing IRS Form 2553, in accordance with all related IRS rules.
I cannot cover all of the pros and cons of making that election here right now.
In closing, I just wanted to mention a tax question that I hear over and over again. I hear it from business owners, and I hear it from professional tax practitioners too:
“Should I operate my new business as an LLC, or as an S Corporation ?”
Well, as I just explained above, your business entity can actually be BOTH! An LLC is not a type of taxable entity for IRS income tax purposes. You can form an LLC under state law, and then elect to receive S Corporation income tax treatment from the IRS.
So, take your time, check your state LLC laws, get good professional guidance, and make the right decisions!
George Prytula III CPA, Professional LLC, World Traveller, Tacos Dad.
