Are You a Legal Professional?

Limited Liability Corporation FAQ

Here are some of most asked questions regarding limited liability corporations (LLC):

I've heard of LLCs, but what exactly are limited liability corporations?

A limited liability company (also known as a limited liability corporation, or just "LLC"), is a structural organization that many businesses choose to use as it combines the simplicity of pass-through taxation with the limited liability that comes with corporations.

The pass-through taxation works as though the profits and losses of the LLC pass directly through to the owners of the LLC. Unlike a corporation, an LLC is not a separate tax entity, meaning that the owners pay the taxes for the LLC. For example, if an owner of an LLC collected $40,000 as his share of an LLC's profits for a year, he would have to add that $40,000 onto his own personal tax statement.

To figure out the limited liability aspect of LLCs, it is useful to look at corporations. People often incorporate their businesses in order to gain the advantage of limited personal liability from their business' dealings. Owners of LLCs enjoy this same benefit of limited personal liability. This means that the owners of the LLC cannot be held personally liable for any debts, judgments or lawsuits against the LLC.

For example, if a business that has been organized as an LLC is facing a monetary judgment from its business liability, only the money and assets of the business can be used to satisfy the judgment, meaning the personal assets of the owners are safe from creditors and others seeking money from the LLC.

So, as some say, LLCs are just a business structure that combines the best parts of corporations and partnerships.

Are there a minimum number of people needed to form an LLC?

No, there are not a minimum number of people needed to form an LLC. If you decide to form an LLC with yourself as the sole owner, however, you must be careful in your actions and documentation to keep your LLC from being considered a sole proprietorship.

Who are LLCs best for?

Creating and maintaining an LLC may be more complex and costly than forming a sole proprietorship or partnership, but it may be worth it for your small business depending upon the type of work you plan on doing. Perhaps the main reason you would want to organize your business as an LLC is to shield yourself from any personal liability that may arise from your small business' dealings.

Organizing your business as a corporation or an LLC makes sense in two situations. First, if the business is engaged in a dangerous activity that makes it more likely to be sued, or if the business has the potential of racking up large amounts of debt, then a corporation or an LLC may be a good idea to shield the owners from personal liability.

For example, if your business engages in a risky activity, like transporting toxic chemicals through urban areas, then you would probably want to shield any personal assets you may have from potential judgments against the company for a spill.

Second, when the owners of a business have large amounts of personal assets that they want to shield from any potential liability associated with the business, forming a limited liability corporation makes a lot of sense. This can be true even if your business is engaged in an generally safe activity, like selling teddy bears. There is always the potential of there being a large judgment against your company. If such an instance arises, forming a limited liability corporation can protect your valuable assets.

Not every business can form as an LLC, though. Businesses that are engaged in banking, trust and insurance are sometimes prohibited from forming as an LLC. Additionally, some states disallow certain professionals (architects, doctors, lawyers, accountantsetc) from coming together to form an LLC. Check your state's laws to find out if your business is eligible to form as an LLC.

How do I go about forming an LLC?

In most states, you will be able to form an LLC by following four (or fewer) simple steps.

First, you will need to find a business name that is available (not taken by another company) and that conforms to your state's rules regarding names for LLCs. If you fear that the name you have chosen for you LLC will be taken before you have had the time to get everything in order to file your paperwork (perhaps you had a falling out with a previous business partner), many states will allow you to reserve a business name for a short period of time in exchange for a fee. In addition, many state governments will tell you whether or not the name you have chosen for you LLC is a valid name under the state's laws

Second, and possibly most importantly, you will need to file your paperwork, normally called the "Articles of Organization," and pay the fee associated with the filing. These documents often go by different names, such as "Certificate of Formation" or "Certificate of Organization" depending upon the nomenclature that your state uses. Do not be afraid of these documents as most states provide easy to use, "fill-in-the-blank" form documents that require minimal writing and some checked boxes. The filing fees can range from between $100 to $800.

Third, make the operating agreement that will dictate how the LLC will be run. This normally lays out all the rights and responsibilities of all LLC members. Although it may not be required by your state that you file an operating agreement for your LLC (most states do not require it), you should still, nevertheless, create one. The operating agreement for an LLC will set out the rules and regulations for both ownership and operation of the business and is one of the key documents that will significantly help in the long run.

Fourth, in some states, publish a notice that you intend to form an LLC. Some states require that an LLC take another step to make the business official, namely that the members must publish a notice to the public in a local newspaper of their intent to form an LLC. This publication requirement normally spells out how long the notice must appear (typically over the course of a few weeks), and also how the members will prove they met the publication requirement (typically by submitting an affidavit of publication). If your state requires this publication, your local newspaper should be able to help you.

I want to form an LLC, do I need a lawyer?

In general, no, you will not need a lawyer to form an LLC. In all states, business owners are allowed to form an LLC simply by filing the articles of organization. At its most basic, these papers will include the name of the LLC, the location of the main office, and names and addresses of all the owners of the LLC, and the name of the LLC's registered agent, or agent of process.

As mentioned before, most states now have simple forms that can be filled out that will prompt you for all of the information necessary to form an LLC. In addition, many states are now so accustomed to working directly with business owners, they will take phone and emails if you have any questions regarding the formation of an LLC.

However, if you are still not sure whether you want to form your business as an LLC or some other organizational structure, you may want take the time to talk with an experience business attorney or expert. In addition, if you are forming a larger LLC, you may want to have an attorney look over your operating agreement before you start operations. Finding problems before you start can save you a lot of time and money in the future.

I have an LLC, do I need an operating agreement?

Although many states do not require every LLC to be run by an operating agreement (typically, states have "default rules" that will govern how an LLC is run absent an operating agreement that says otherwise), it is still probably in your best interest to have one. Here are some reasons why having an operating agreement is a great idea:

  • It will establish rules regarding the sharing of profits and losses among the owners.
  • It will dictate how meetings are held as well as lay out the voting rights of all members.
  • It can help ensure that your business' status as an LLC will be legitimate and more respected by a court when considering your limited personal liability.
  • It can possibly resolve conflicts between owners before they arise.
  • It avoids the default rules that would be imposed by the state absent an operating agreement.

How will my LLC be taxed?

Unlike corporations, LLCs are not considered to be a separate tax entity, meaning that the taxes pass-through to the owners of the business (like sole proprietorships and partnerships). The LLC, in general, does not pay income taxes for itself. However, the owners of the LLC must pay taxes on their share of the profits from the LLC on their personal tax returns.

However, LLCs may elect to be taxed like corporations, meaning that the LLC would pay taxes on its profits, instead of passing the taxes through to the owners.

Are there differences between a limited liability corporation and a partnership?

An LLC, unlike a partnership, provides limited liability to the owners of the LLC for the business' liabilities, including debts, judgments and others. Because of this, if a judgment is ever issued against the LLC, or if a creditor is seeking payment from the LLC, they cannotobtain payment from your personal assets (real estate, bank accountsetc). A partnership does not provide this type of protection. Instead, the general partners in a partnership are directly liable for the debts, judgments and other liabilities of the partnership (there is an exception for partners that are designated as "limited partners.")

Another difference can be seen in how both types of business organizations are formed. While owners of LLCs must file articles of organization, pay a fee and comply with other laws of the state in order to be official, partnerships do not have to do any of this. Partners simply declare that a partnership exists, and it does.

However, because LLCs are not their own, separate tax entity, LLCs and partnerships are taxed very similarly. They both use a "pass-through" tax system where the profits and losses are passed through to the members, and it is the members that are taxed, not the business.

Am I stuck with my existing business structure, or can I change to an LLC?

You are not stuck with your original business structure if you want to change it to an LLC. Sole proprietorships and partnerships routinely switch to a limited liability corporation structure when the businesses grow, become more dangerous, or when the owners have more assets that they wish to protect.

There are some states that provide simple forms that businesses may use to switch from one business organization to another. These forms are sometimes called "certificates of conversion," and may be found on your state government's website. If your state does not provide such a form, you can simply file articles of organization in order to change your sole proprietorship or partnership to an LLC.

Keep in mind that there are still some states that require any planned LLC to publish notice to the public of its intent to form an LLC. Your local newspaper will be able to help you with this process.

In addition, you should also be ready to transfer all of your licenses and permits (business, federal employer ID, state employer ID, sales taxetc) to the name of your new business organization.

What securities laws impact LLCs?

Many people wonder and worry about the potential securities laws that will affect their new LLC. If you plan on being the sole owner of your LLC and are not thinking of attracting other investors to become owners of your business, then you will not need to worry about securities law.

By definition, a security is an investment in a profit-making enterprise that is not run or controlled by the investor. Therefore, if you are planning on having more than one owner (member) in your LLC, then you may have to worry about securities laws. When a person invests in a company and expects to make a profit because of the work of other people, the government will consider the company to be a security. It is worthwhile to keep in mind that the converse is true as well. If you plan on investing money in a company, and expect to receive profits, but also plan on working for and in the company, then the investment is not a security.

This second scenario is played out in a lot of start up companies where all the owners of the LLC are actively engaged in the running, growing and management of the company. Even if these people derive profits from their LLC, it will not be considered a security because the investors expect to profit, in part, from their own work within the business. However, if there is just one investor in the company that does not participate in the management or running of the company, then the LLC may be considered a security by the federal Securities and Exchange Commission (SEC).

If some of the ownership interests in your business will be considered securities by the SEC, you must ensure that you qualify for an exemption from the securities law before you take money from the investors in your LLC. If you cannot qualify for the exemption, you must register the sale of the interest in your LLC with the state and the federal SEC.

Small businesses that plan on forming into LLCs regularly qualify for the securities law exemption, even if they plan on selling ownership interests to non-participating investors. For example, the SEC runs the exemption to LLCs that have all of their owners within one state (even the passive ones), and that only sell goods within that state (called the "intrastate exemption.") There are other exemptions as well, such as the "private offerings" exemption which exempts LLCs that sell to a small number of people (normally fewer than 35), or to people that can reasonably be expected to look after their own investments without government protection.

You can find out more about the SEC exemptions by visiting the Securities and Exchange Commission at http://www.sec.gov.

Next Steps
Contact a qualified business organizations attorney to help you
choose the best formation for your business.
(e.g., Chicago, IL or 60611)

Help Me Find a Do-It-Yourself Solution