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Should You Form an LLC For Your Small Business?

Forming a limited liability company (LLC) is an easy and inexpensive way to structure your sole proprietorship or small business. Here's what an LLC will and won't do, and when you should consider forming one.

If you have a business – either a sole proprietorship or partnership – you should seriously consider setting it up within an LLC. It will provide you with similar legal protections to a corporation, but enable you to run your company as a small business.

What is an LLC?

LLC is an abbreviation for limited liability company. It’s a business structure that provides a business with limited liability (similar to a corporation), but the structure is easier to establish and simpler to maintain. It also provides the business with pass-through treatment of income for tax purposes, similar to that of a sole proprietorship or a partnership.

Owner’s limited liability

This is where the term “limited liability” in LLCs comes from. The LLC provides protection to the LLC owners by limiting the owner’s personal liability. Generally, this means that business debts owed by the business, and other claims on the business, including liens and lawsuits, are limited to the assets of the business itself. Those holding such liens against the business cannot pursue the personal assets of the business owner(s) in most states and under most circumstances.

This protection, however, does not extend to illegal acts committed by the owners of the LLC, and can also be lost in the case of certain instances of negligence on the part of the owners.

Pass-through treatment of income taxes

Unlike a corporation, an LLC is not considered to be a distinct entity for income tax purposes. The owner(s) of the LLC report their operating results, including profit or loss, on their personal income tax returns, just as they would as either a sole proprietorship or partnership. No return is filed specifically for the LLC.

How to set up an LLC

Setting up an LLC is a pretty simple process, especially compared to setting up a corporation. It’s actually a multistep process that looks something like this:

Choose a business name

There are two considerations here, the first being to choose a name that doesn’t duplicate that of an existing LLC in your state. Your state will let you know if the name you choose is acceptable.

The second consideration is that your business name must comply with state regulations in regard to LLC names. Generally, this means that “LLC” or “limited liability company” must appear in your business name. There may be other requirements depending upon the state where you are attempting to establish your LLC.

Create and file Articles of Organization

The name of this document may be slightly different from one state to another, but it is the basic document that establishes your LLC.

The article can be quite simple—in fact, your state may have a standard form that will enable you to fill in blanks. The information requested will be simple and basic, such as your LLC’s name, address, and typically the names of the owners of the business. In some cases, each owner will be required to sign the document, but in others a single owner can be appointed to sign alone.

Appoint a Registered Agent

Most states require that one person act as the registered agent for the LLC. The registered agent is the person representing the LLC and is designated to receive any legal documents relating to a lawsuit. A registered agent is typically one of the owners of the LLC.

Payment of required fees

The amount of fees required to register your LLC will depend upon the state where you live. It can be as little as $100 in some states, to several hundred dollars in others.

Publish a notice of intent to create an LLC

This is a requirement only in some states. Your state may require that you publish a legal notice in a local newspaper announcing your intent to form an LLC. The newspaper staff should be able to assist you in creating this notification. You may be required to publish the notice several times over a period of weeks or months, after which you may have to file an affidavit of publication with the state.

If you need to launch your LLC quickly, publishing this type of notice can delay the process. Be sure to check with your state to see if this is a requirement, and, if it is, allow plenty of time to meet the requirement.

Create an LLC Operating Agreement

This is probably the most complicated part of creating an LLC, but the good news is that the document is not necessarily required to be filed with the state. Still, you should create an operating agreement for your LLC to avoid conflicts later.

Even this document can be relatively simple, and does not necessarily need to be prepared by an attorney (though it’s never a bad idea in the case of an LLC with multiple owners).

The purpose of the operating agreement is to spell out the rights and responsibilities of each owner of the LLC. It is very similar to corporate bylaws or to partnership agreements, which are largely intended to provide a framework to deal with conflicts or with the transfer of ownership between partners, both existing and new.

The operating agreement should provide for owners’ rights and responsibilities, voting power, percentage interests in the business (including division of profits and losses), and the scheduling of owners meetings. A very detailed operating agreement may even include management responsibilities between several owners.

The agreement can be as detailed as you need it to be, but it’s a necessary document if there is potential for any disagreement between owners over either the ownership or management of the LLC.

And don’t be intimidated by the form requirements, either. You can often get them from your state offices, or through a general web search (just make sure they’re specific to your state). Failing all else, you can always check out, or one of their competitors, for low cost pro forma legal documents.

How an LLC can benefit a small business

Probably the most obvious advantage to forming an LLC is protecting your personal assets by limiting the liability to the resources of the business itself. In most cases, the LLC will protect your personal assets from claims against the business, including lawsuits.

This enables the small business owner—of sole proprietorships and partnerships—to gain the limited liability protection similar to that offered by corporations, but without the cost and complexity that corporations bring. For example, under an LLC, you will not need to file a separate tax return for your business. Your income and expenses will continue to be reported on your individual income tax return, either on Schedule C for sole proprietorships, or on Schedule E for partnerships.

There is also the tax benefit to an LLC. This is particularly true in relation to “C corporations,” which the IRS recognizes as independent entities. Taxes must first be paid on net income to a corporation, before that income is distributed to the owner, where it is taxed again at an individual level. This is what is known as double taxation, which you can avoid entirely with an LLC. (You can also avoid it with a Subchapter S Corporation but that will still involve a complicated set up, as well as ongoing compliance and filing requirements.)

Still another benefit is something of a soft advantage: having “LLC” or “Limited Liability Company” in your business name can make your business seem somehow more official. It implies that the business is registered with the state, and is somehow more substantial as a legal entity.

If you have a small business, either a sole proprietorship or partnership, you should take a serious look at creating an LLC. That will enable you to gain important legal protection for your personal assets, without disturbing the management and income flow of your business.



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