For business owners looking to form their company in a flexible way and limit their own exposure to lawsuits or other negative consequences, limited liability companies are a very attractive option. Though relatively new compared to corporations or partnerships, LLCs are becoming increasingly popular because of the benefits they give to owners, who are referred to as members.
The limited liability company can be formed by a number of members, and these members do not necessarily need to be people. An LLC can be formed by a corporation, a foreign entity or even another limited liability company. These members are not tied to the tight restrictions of that comes with a partnership, which require them to share profits equally, but instead can determine how to best split up profits. They can also use any financial losses as a deduction on their personal income taxes.
One of the most attractive parts about a limited liability company is its flexibility. The IRS does not recognize an LLC as an official tax classification, so members are free to choose to have it structured like a corporation or more like a partnership. They are also free from the tedious requirements the government places on corporations—things like officials meetings with minutes and resolutions.
The structure of a limited liability company was created in Germany in 1892, and spread through Europe and Latin American during the early 1900s. Limited liability companies did not catch on in the United States until a bit later, with Wyoming being the first state to enact a true act allowing LLCs in 1977. Because of the lack of history for LLCs and some gray areas surrounding legal issues, business experts suggest those who start this type of business have a trusted accountant or lawyer to help with the formation process and beyond.
When it comes to actually forming the LLC, the process and exact requirements vary by state. In general, anyone starting an LLC must file what is known as “articles of organization” with the office of their secretary of state. This is a simple form that tells the name of the limited liability company along with names and contact information for all members. There is usually a fee involved with filing this form, which can range anywhere from $30 to more than $100. In addition many states have annual fees, which are generally around $100, but there are some exceptions. California has an $800 tax on LLCs each year, and an annual fee based on annual income over $250,000 that can be as high as $11,760.
Coming up with the name is an important step in the formation process, and though rules for naming vary by state there are some general guidelines that apply. For one, it must be a unique name not already in use by another limited liability company. It also must not violate any trademarks held by other companies. The name must end in a way that designates it as an LLC, with either Limited Liability Company or some acceptable abbreviation. Because there are some restrictions on which kind of organizations can become limited liability companies—banks or insurance companies are not allowed—the official name can’t contain the words bank or insurance. Other words like corporation and city are also prohibited.
Members don’t actually need to hire a lawyer to complete the formation process as the requirements put out by states are usually self-explanatory, but business experts suggest at least consulting with an attorney who can look over the required paperwork. There is also a wealth of help available online regarding the formation process, and those interested can find information and forms at our site.
Experts also suggest another step not legally required when forming an LLC—writing up an operating agreement that puts specifics to the business arrangement. Because of the flexible nature of limited liability companies, it is best to clearly define the roles of the members and what rights and responsibilities they each have. An operating agreement can also spell out how profits will be split up. This agreement will become very important if the LLC’s structure is ever challenged in court, because without a plan specific to the company it would have to use the state’s operating rules by default.
There are other non-required steps that are still recommended for LLCs. These businesses are not required to hold any meetings at all, but legal experts say some holding one at least one meeting a year to discuss major proceedings will help protect the company’s legal status.