Launching your own business is a huge decision, one not to take lightly. From developing your product or service and getting funding to taking measures to protect your business, entrepreneurs must do their homework. As a business and tax attorney, one question I often hear is:
What is the best way to set up a new business?”
While the answer varies depending on the goals of each client, an LLC is often chosen.
What is an LLC?
An LLC, or limited liability company, is a U.S. business structure that combines the simplicity, flexibility, and tax advantages of a partnership with the personal liability protection of a corporation. The owners of LLCs are called members. An LLC can have one or many members. Members can be individuals or other businesses, and there is no limit to the number of members an LLC can have. With an LLC structure, members’ personal assets are protected from the LLC’s creditors. LLCs are more cost effective and simpler to form than a corporation. This, in addition to the discussion below, has led to LLCs becoming the ‘go-to’ business structure to form.
Who should form an LLC?
Generally, any person who is starting a business or is currently running a business should consider forming an LLC. But LLCs are not only great to operate a business, they are also great to hold assets to limit liability. For example, placing rental property into an LLC will protect the members’ other assets from liability (those assets that are not owned by the LLC). This concept will also work with intellectual property assets, such as separating the trademarks and patents from the operating entity.
What are the benefits of an LLC?
There are four benefits of forming an LLC:
- Personal asset protection. An LLC provides its members with limited liability. This means the LLC member generally is not personally liable for any debts incurred by the LLC and the majority of related lawsuits. Since the members are not personally liable, those who initiate a suit against the LLC cannot collect against the members’ personal assets, such as bank accounts, personal car, or home. They are generally limited to those assets of the LLC.
- Pass-through taxation. Simply put, LLCs will ordinarily provide their members with pass-through taxation. This means that the profits and losses that the LLC incurs will pass through to the members on the members’ personal tax return. These profits will be taxed at the members’ personal tax rates. LLCs only have one layer of taxation.
- Simplicity. An LLC is the simplest business entity to form and operate. With an LLC it is not required to have officers and directors, board or shareholder meetings, other similar administrative burdens that come with a corporation. This does not mean that the LLC is not governed by state law or the governing documents of the LLC, it only means there are less administrative burdens with an LLC.
- Flexibility. LLCs provide enormous flexibility with respect to ownership, management, and taxation. LLCs do not have any minimum or maximum number of members unless the LLC has elected to be taxed as an S-Corporation. The governing documents of the LLC may determine which events require majority consent or unanimous consent, what is to occur upon the death of a member, and the LLC having a first right of refusal to purchase membership interests, among many other events that may be controlled by the governing documents of the LLC.
LLCs can also choose how they want to be taxed. Typically, LLCs are taxed as a sole proprietorship (single-member LLC) or a partnership (multi-member LLC). However, both with a sole proprietorship and a partnership each may elect to be taxed as an S or C-Corporation. This is performed by filing an election with the Internal Revenue Service indicating the LLC’s desired tax classification (these elections must be submitted within the applicable time period). A reason an LLC may elect to be taxed as an S-Corporation is to save on FICA taxes (self-employment taxes). If the LLC elects to be taxed as an S-Corporation, the members of the LLC who work for the LLC will only pay Social Security and Medicare taxes on their actual compensation rather than on all of the LLC’s pre-tax profits. An LLC that does not elect to be taxed as an S-Corporation will result in the members who work for the LLC being classified as “self-employed” and will owe FICA taxes on the LLC’s total net earnings.
What are the disadvantages of an LLC?
Although the cost to form an LLC is less than forming a corporation, there is still a cost associated with forming and maintaining an LLC. To form an LLC in Florida, one must file Articles of Organization with the State. Florida requires all entities to file an Annual Report each year and failure to file an Annual Report will result in the LLC being administratively dissolved. It is cheaper to file the Annual Report rather than to reinstate an LLC. In addition, the LLC should have an operating agreement drafted by an attorney and adopted by the LLC. Depending on the line of business the LLC is operating, the LLC may need to renew licenses and permits annually as well.
Limited liability has limits, though. The failure of the members to follow state law and the governing documents of the LLC may result in a court “piercing the corporate veil.” This means that the assets of the members of the LLC will be subject to liability. Common examples of reasons why a court may “pierce the corporate veil” are:
- a member has committed fraud or other illegal business activities;
- a member has done an act to compromise the line of separation between the business and personal transactions; or
- a member has not managed the LLC in accordance with the operating agreement.
Join us in Naples for StartUp Bootcamp
The above only discusses one aspect entrepreneurs need to know before starting a business. Join us on Tuesday, November 16, 2021, from noon to 4:00 pm at Ave Maria Law School in Naples for StartUp Bootcamp. Click here to download the brochure.
Ave Maria Law School CEO, Dean Czarnetzky, will kick off the event and share information on its Business Institute. Next, I will discuss two fundamental aspects of a business – how to set it up and how to protect it. The closing panel will provide real-world advice from three guest speakers on how to get funding:
- Timothy J. Cartwright, Fifth Avenue Family Office, Partner; Tamiami Angel Funds, LLC, Chairman and Co-Founder; and Adrenaline Venture Fund, General Partner
- Blake M. Cathey, Chief Operations Officer of Accanito Capital Group
- Dan H. Vo, Assistant Professor of Entrepreneurship Daveler & Kauanui School of Entrepreneurship at Florida Gulf Coast University
Registration is $40 for live in-person attendance or $20 if attending virtually. Admission is complimentary for students. To register, click here.
If you should have any questions regarding setting up an LLC, I may be reached at firstname.lastname@example.org or by phone at 239-344-1147.