We’re always speaking with creators looking to start a company based on their product idea, and the question of incorporation often comes up. Luckily, we’re also always speaking to experts in such things. The remainder of this post is what one of Crowd Supply’s financial advisor friends has to say about forming an LLC:
When creating a new business one needs to decide on a company type for legal and tax purposes. If no selection is made the entity is assumed to be a sole proprietorship. Forming a LLC, or limited liability company, to protect and support a new hard goods business is often the best company type for an individual or small group. Similar to partnerships, LLCs have many of the same legal protections a Corporation offers, without expensive and time consuming corporate fees, paperwork and formalities. Rules for forming a LLC vary by state and new LLCs should be formed only after, at a minimum, review of your state’s company formation website. A good place to find that site is to search for your Secretary of State’s site.
Contrary to popular belief, you do not need to hire a lawyer to set up a LLC. Many state requirements are self explanatory. However, inexpensive online services like LegalZoom can make the process easier. Even with such a service, it’s a good idea to have an attorney read over your paperwork. This additional expense will make sure your interests are protected. It will also help you build a professional relationship with a lawyer as your legal needs grow. You will want this professional support (in addition to a CPA and a Financial Planner ) if your company is going to be successful in the long term.
Though it’s often not required by law, you should draft an “operating agreement” for your LLC which spells out the details of the business arrangement. Include in this agreement:
- percentage ownership for each member
- roles of each member in the company
- the rights of each member
- the responsibilities of each member
This sort of agreement can help protect the LLC structure if it is challenged in court. It also may prevent you from having to fall back on your state’s operating rules.
New LLCs must file articles of organization with their secretary of state’s office. This is typically a short form which asks for the name of the LLC, its members and their contact information. Filing fees vary but typically range from $50 to $200. Some states have other registration requirements.
Most states don’t require significant annual paperwork or administrative procedures but you should document major business proceedings and maintain formal procedures of some kind. For example it is a good idea to hold and document an annual meeting of the LLC. This will to help protect your status.
Several states charge annual fees and taxes that can diminish the economic advantage of choosing to become a LLC. With regard to taxation, LLCs provide tax as well as investment opportunities. (This is where you may want to hire a CPA for taxes and a Financial Planner for investments.)
If the owners of the LLC keep the business’s profits in the LLC, to support the growth of the business; the preferred option is usually a C corporation tax designation. As a C Corporation, the LLC’s profits are only be subject to the 15 percent corporate tax rate. Which will often be less than the owners’ personal marginal income tax rates. If any of the LLC’s owners want to receive compensation, they can be paid W-2 wages for their business-related work efforts. W-2 income can be a benefit when desiring to show income to a bank for personal loans (home, auto, line of credit loan, etc.) or when wanting to make contributions to college savings accounts or personal retirement accounts.
Conversely if the LLC owners want to take some or even all of the profits out of the business, a S corporation selection is likely a better choice. Each owner or member can receive his or her proportionate share of the LLC’s total profit as distributions of profit. These distributions are taxed at the owners individual marginal income tax rates. But they are not subject to Self-Employment Tax.
In short, some advantages to forming a LLC include:
- Owners aren’t usually responsible for the company’s debts and liabilities.
- Profits and losses “pass through” the business to the individuals owning the business.
- These profits and losses are easily reported on the owner’s personal tax returns.
- The result can be fewer taxes because profits aren’t taxed at both the business and personal level.
- Owners can also choose to be taxed as a partnership, corporation, S or C corporation.
- These tax choices support personal borrowing, savings, investment and tax advantages.