Why form an LLC? An LLC introduction.

STARTright is the web’s easiest and most efficient way to form an LLC.  Some of our new members have asked me to write an LLC introduction or an overview of why someone would want to form an LLC.  I spent about an hour on the phone with one of our member’s the other day (she is from Arizona, and I only practice and am barred in Arizona, so I cannot advise at length to people outside of Arizona).   I realized that some basic LLC fundamentals concerning how one forms an LLC, how an LLC is taxed, the liability protections of an LLC and general use of an LLC in one’s business where not well understood.  So in order, lets talk about the why’s and how’s of forming an LLC.

 

Why form an LLC?

Forming an LLC is the right decision for almost any small business owner or partnership.  Most business owner’s are worried about three issues when starting their business.  Those issues are 1) start up costs, 2) lowering tax liability, and 3) liability protection.  I will discuss how forming an LLC is the best solution for each of these.

 

1. Forming an llc minimizes start up costs.

There is no question that hanging your sign and opening your doors for business will have the lowest start up costs.  This may not be the most prudent approach, however.  It also may not end up saving that much over forming an LLC.  When you start a business without forming a legal structure from which to operate that business, you still need to get a business license in order to open a business account at a bank.  In most counties, a business license can run upwards of $100.  If you form an LLC, you can usually get the Articles of Organization filed with the state for under $100 (states vary, but the vast majority do not charge over $100).   Almost any financial institution will open an account for your LLC based upon a filed copy of the Articles of Organization.   With that said, the savings you gain by not forming an LLC which is recognized and given state LLC law protections may be minimal and probably not worth it.

 

If the question is whether to form an LLC or another entity, the choice to form an LLC to save on startup costs is even clearer.  For a single business owner, the only other legal entity available is a state corporation.  Both the LLC and corporations offer legal protections which we will address shortly.  Fees to form an LLC as opposed to the fees to form a corporation are cheaper in most state.   LLCs are generally less complex and require fewer formalities.  This enables business owners to properly manage much of the LLC themselves cutting down on legal bills.  Many business owners that have corporations may choose to manage their corporation themselves, but few do it right.  Corporations have strict formality and structural rules.  As we will discuss later, the protections for those corporations are dependent upon those formalities being executed properly.   

 

2. LLCs have the most tax flexibility.

Many people complain about the complexity of the federal tax code, but it was designed to deal with the fact that no two businesses are completely alike.  For some businesses the ease and convenience of flow through taxation (that of a sole proprietorship) where the business is listed as an extension of the business owner’s person assets fits.  For others, the “self-employment tax” minimization of an S-Corporation fits, and for others, the large benefit write-offs of a C-corporation fits.  Before business owners could form and operate from an LLC, federal tax choices did not line up well with state structure and liability choices.   A business owner seeking corporate veil protections could not also get sole-proprietor type tax flexibility and vice versa.   By forming an LLC, you can keep the structure and formalities of your business simple and minimal, the protections at the highest levels allowed in any state, and choose the tax structure that works for you.

 

3. Forming an LLC gives you premier legal protections.

An LLC carries the greatest level of protections from legal liability available today.   Most people do not realize that the liability pendulum can swing from two directions.  The LLC offers both 1) corporate veil protections as well as 2) statutory business asset protection (the charging order).   

The LLC’s corporate veil protection is superior for one main reason.  The corporate veil is only as good as a judge says it is, and whether or not a judge will acknowledge or pierce the corporate veil depends upon the state law requirements for maintaining the businesses’ veil protection.  Corporations have lists of formalities and structural requirements such as shareholders, directors and officers that require lots of documentation to ensure corporate veil protection.  An LLC usually requires the owner to keep his business and personal finances separate and that will generally ensure legal protections.  Much easier.

Now we will look at the other way the liability pendulum will swing. Most business owners realize that they want to protect their personal lives from their business, but what they often fail to do is to protect their business from their personal life.  By forming an LLC, a business owner ensures that anyone who sues him personally will not get instant and unlimited access to the business and its assets.  Instead, the LLC is protected by state statutes that require a judge to limit the plaintiffs access to the business.  This is called a charging order.  Unlike a state corporation where a plaintiff could take all the shares and control the corporation including forcing it into liquidation, by forming an LLC, you ensure that you as the business owner retain control of the LLC management even if you are sued personally.  I will write more on charging orders later, and this is supposed to just be a quick overview.  It is important to understand the limitations involved with a single member LLC when it comes to statutory business asset protections also.  Please read “The Single Member Hitch” for more on Single Member LLC Protections.