Setting Up an LLC: A Step-by-Step Guide
A Limited Liability Company, or LLC, is a flexible business structure that offers the protection of limited liability for its owners, while allowing for pass-through taxation. LLCs are becoming increasingly popular as a way for small businesses to organize and operate. If you are considering setting up an LLC, here are the steps you need to follow:
Step 1: Choose a Name for Your LLC
Before you can start setting up your LLC, you need to choose a name for it. The name should be unique and not already in use by another business in your state. You can check the availability of your chosen name by searching your state’s business entity database. Once you have confirmed that your chosen name is available, you can reserve it with your state’s secretary of state. Most of my clients register their companies in California. The California Secretary of State provides an online tool for registering the corporation’s name.
Step 2: File Articles of Organization
The next step is to file Articles of Organization with your state’s secretary of state. This document includes basic information about your LLC, such as its name, address, and the names and addresses of its members. Most of my clients register their LLCs in California, although a few register in Delaware or other states.
Step 3: Obtain an Employer Identification Number (EIN)
An Employer Identification Number, or EIN, is a unique nine-digit number that is assigned to your LLC by the IRS. This number is used to identify your LLC for tax purposes and is required if you plan to hire employees or open a bank account for your business. You can apply for an EIN online through the IRS website.
Step 4: Determine the Company’s Tax Status
One of the most attractive traits of an LLC is its flexibility. An LLC can be taxed as a sole proprietorship, partnership, C-corporation, or S-corporation, depending on the situation:
- By default, an LLC with a single member will be taxed as a sole proprietorship but can elect to be taxed as a C-corporation or S-corporation. An LLC with a single member cannot elect to be taxed as a partnership.
- By default, an LLC with more than one member will be taxed as a partnership but can elect to be taxed as a C-corporation or S-corporation. An LLC with more than one member cannot elect to be taxed as a sole proprietorship.
In my experience, the default rules tend to work well. But there can be reasons to elect out of the default rules. Be sure to talk with your tax advisor and attorney about the pros and cons of the various choices.
Step 5: Draft an Operating Agreement
An Operating Agreement is a legal document that outlines the structure and operating procedures of your LLC. It establishes how the LLC will be run, how decisions will be made, and what the roles and responsibilities of the members will be. This document is not filed with the state, but it is an important document that should be drafted before the LLC begins operations. Be sure to talk with your tax advisor and attorney to ensure that your LLC’s Operating Agreement fits your company’s needs. For example, many generic Operating Agreements drafted for multi-member LLCs include partnership-tax terms. If you elect to have your LLC taxed as an S-corporation, these inappropriate partnership-tax terms may jeopardize your S-election.
Step 6: File Any Required Securities Exemption Notices
The LLC membership interest you issue to the LLC members are “securities” for purposes of the state and federal laws designed to protect investors. Failure to understand and follow these laws can lead to severe civil liability and criminal penalties. There are some useful exemptions which are designed to allow small companies to issue LLC membership interests to a limited number of initial investors. It is vital to understand and comply with the exemption you plan to rely upon, including filing any necessary notice filings with state and federal regulators.
Step 7: Register for State & Local Taxes and Licenses
Depending on the nature of your business, you may need to obtain various business licenses and permits before you can begin operations. In California, most businesses are required to obtain a business license from the cities in which the operate. California also requires retailers to obtain a seller’s permit and to collect and pay sales taxes. These requirements vary by state and industry, so it’s important to research the requirements for your specific business.
Step 8: Open a Bank Account
Once your LLC has an EIN, it can open a bank account. This is a critical step. All of the LLC’s funds, such as the capital contributions paid by members and any income from business activities, should be deposited in the LLC’s bank account. Similarly, the LLC’s expenses, such as rent, payroll, utilities, etc., must be paid out of the corporation’s bank account. The LLC will not protect its owners unless it operates as a separate “person” with its own bank account under the LLC’s name and EIN. So, be sure not to “commingle” the corporation’s money in anyone’s personal bank account.
Step 9: Get Insured
Maintaining adequate insurance is critical to the success of every business. Most companies need commercial general liability insurance coverage, such as workers’ compensation, auto, or professional liability. Depending on the nature of the business, the company may also need other types of coverage. It is almost always a good idea to talk with your insurance agent about the corporation’s insurance coverage.
Setting up an LLC can seem like a daunting process, but by following these steps, you can ensure that your LLC is set up properly and ready to start operating. It’s important to consult with an attorney or accountant who can provide guidance on the specific requirements and regulations in your state. With the proper preparation and guidance, you can establish an LLC that will provide the protection and flexibility you need to succeed.
