What is a Limited Liability Company (LLC)?

 

  • An LLC is an unincorporated business organization of one or more persons who have limited liability for the contractual obligations and other liabilities of the business.  The Limited Liability Company Law of New York governs the formation and operation of an LLC in New York. Other US states have similar governing statutes. An LLC may organize for any lawful business purpose or purposes. 

 

  • A limited liability company is a hybrid type of legal structure having the limited liability characteristic of a corporation and the “pass-through” income taxation of a partnership. An LLC is more flexible than a corporation, and it is well-suited for companies with a single owner.

 

  • The owners of an LLC are called “members” rather than shareholders or partners.  A member may be an individual, a corporation, a partnership, another limited liability company or any other legal entity.

 

  • Unlike shareholders in a corporation, LLCs are not taxed as a separate business entity. Instead, all profits and losses are "passed through" the business to each member of the LLC. LLC members report profits and losses on their personal federal tax returns, just like the owners of a partnership would. The LLC is a hybrid form that combines corporation-style limited liability with partnership-style flexibility.  The flexible management structure allows owners to shape the LLC to meet the needs of the business.

 

How is an LLC formed?

 

In most states, including Delaware and New York, forming an LLC typically involves the following steps:

 

1.   Choose an available business name that complies with your state's LLC rules. There are three basis rules to follow in naming an LLC: (1) it must be different from an existing LLC in your state, (2) it must indicate that it is an LLC (such as "LLC" or Limited Company") and (3) it must not include words restricted by your state (such as "bank" and "insurance").

 

2.   The “organizer” of the LLC files the articles of formation / organization with the Secretary of State or other appropriate state authority and pays the state filing fee (ranging from about $100 to $800, depending on the state). Any person or business entity may be an organizer of an LLC.  Typically, an organizer may be, but need not be, a member of the LLC formed.

 

3.   Appoint a registered agent for service of process. 

 

  • In Delaware, each LLC must have an agent for service of process in the state. This is an individual or business entity that agrees to accept legal papers on the LLC’s behalf if it is sued. If the LLC is physically located in Delaware, it may act as its own registered agent. A registered agent may be either an individual resident or business entity that is authorized to do business in Delaware. The registered agent must have a physical street address in Delaware.

 

  • In New York, each LLC must appoint the New York Department of State as its registered agent for service of process in the state. The Department of State will accept and forward legal papers on the LLC’s behalf if it is sued.

 

4.     Create an LLC Operating Agreement, which sets out the rights and responsibilities of the LLC members. The LLC Operating Agreement is purely an internal document and is not filed with the state. An operating agreement is highly recommended for multi-member LLCs because it structures your LLC's finances and organization, and provides rules and regulations for smooth operation. The operating agreement usually includes percentage of interests, allocation of profits and losses, member's rights and responsibilities and other provisions.

 

  • In Delaware, an LLC operating agreement is not required by law, but it is highly advisable to adopt such an agreement.

 

  • Unlike most states, New York requires LLC members to adopt a written operating agreement.  The Operating Agreement may be entered into before, at the time of, or within 90 days after filing the Articles of Organization. 

 

5.   Publish a notice of your intent to form an LLC in certain local newspapers (required in New York and a few other states).

 

  • Delaware does not have any publication requirement.

 

  • In New York, within 120 days after an LLC’s articles of organization become effective, that LLC must publish a copy of the articles or a notice related to the formation of the LLC in two newspapers. These newspapers are designated by the county clerk of the county in which the office of the LLC is located. After publication, the printer or publisher of each newspaper provides an affidavit of publication. A Certificate of Publication, with the affidavits of publication of the newspapers attached, must be submitted to the New York Department of State. The fee for filing the Certificate of Publication with the New York Department of State is $50.

 

6.     Obtain licenses and permits that may be required for your business.

 

  • EIN (Employer Identification Number): If your LLC has more than one member, it must obtain its own EIN from the US Internal Revenue Service (IRS), even if it has no employees. If you form a one-member LLC, you must obtain an EIN for it only if you elect to have it taxed as a corporation instead of a sole proprietorship (disregarded entity). You may obtain an EIN by completing an online application on the IRS website. There is no filing fee.

 

  • Business Licenses: Depending on its type of business and where it is located, your LLC may need to obtain other local and state business licenses.

 

7.   Pay your state’s annual tax obligations.

 

  • In Delaware, all LLCs must pay an annual $250 franchise tax by June 1 of each year. The tax is paid to the Delaware Division of Corporations Franchise Tax Section.

 

  • In New York, every LLC that is treated as a partnership or disregarded entity for federal income tax purposes that has any income, gain, loss, or deductions derived from New York sources is subject to an annual filing fee. An LLC that elects to be treated as a corporation for federal income tax purposes is not subject to the filing fee. An LLC or LLP that owes the filing fee must file Form IT-204-LL, Partnership, Limited Liability Company, and Limited Liability Partnership Filing Fee Payment Form (available on the New York State Department of Taxation and Finance website). The fee ranges from $25 to $4,500 depending on the LLC's income.

 

8.   Comply with rules applicable to Foreign (out of state) LLCs if your LLC is “doing business” in that state.

 

  • In Delaware, all LLCs organized outside of Delaware and doing business in Delaware must register with the Delaware Secretary of State to do business in Delaware. Foreign LLCs must appoint a registered agent for service of process physically located in Delaware. To register as a foreign LLC, you must file a Certificate of Registration of Foreign Limited Liability Company, which must be accompanied by a Certificate of Existence, dated within 6 months prior to the filing of the certificate, from the foreign LLC’s home state. There is a state filing fee applicable to this filing.

 

  • In New York, all LLCs organized outside of the state and doing business in New York must register with the New York Department of State Division of Corporation. Foreign LLCs must appoint a registered agent for service of process physically located in New York. To register, you must file an Application of Authority with the Division of Corporations. The application must be filed by mail. The application must include a certificate of existence or similar document from the LLC's home state that is no more than one year old. There is a state filing fee applicable to this filing.

 

How is an LLC taxed at the federal level?

 

  • For US federal tax purposes, an LLC is not a separate tax entity and business itself is not taxed. Instead, all federal income taxes are “passed through” to the LLC's members, who pay personal income taxes on the income they receive from the LLC. While the federal government does not tax income on an LLC, some states do, so check with your state's income tax agency.

 

  • All LLCs must file as a corporation, partnership, or sole proprietorship tax return, depending on certain tax election that the LLC may decide to make. Certain LLCs are automatically classified and taxed as a corporation by federal tax law. For guidelines about how to classify an LLC, visit www.irs.gov. The IRS guide to Limited Liability Companies provides all relevant tax forms and additional information regarding their purpose and use.

 

What are the advantages of an LLC?

 

  • Limited Liability. Like shareholders of a corporation, the members of an LLC have protection from personal liability for business decisions or actions of the LLC. This means that members are protected from some or all liability for acts and debts of the LLC depending on state shield laws. Keep in mind that limited liability means "limited" liability - members are not necessarily shielded from wrongful acts, including those of their employees.

 

  • Choice of Tax Regime. An LLC can elect to be taxed as a sole proprietor, partnership, S corporation or C corporation (as long as they would otherwise qualify for such tax treatment), providing for a great deal of flexibility.

 

  • Pass-through Taxation. No double taxation at the entity and, again, at the member level, unless the LLC elects to be taxed as a C corporation.

 

  • Simplified Recordkeeping. Compared to a corporation, there is less registration paperwork and there are smaller start-up costs.

 

  • Flexible Sharing of Income / Profits. There are fewer restrictions on profit sharing within an LLC, as members distribute profits as they see fit. A limited liability company with multiple members that elects to be taxed as partnership may specially allocate the members' distributive share of income, gain, loss, deduction, or credit via the company operating agreement on a basis other than the ownership percentage of each member so long tax criteria and rules are complied with. 

 

What are the disadvantages of an LLC?

 

  • Self-Employment Taxes. Members of an LLC are considered self-employed and must pay the self-employment tax contributions towards Medicare and Social Security. The entire net income of the LLC is subject to this tax.

 

  • High Franchise Taxes. Some states, including New York, levy a franchise tax or capital values tax on LLCs. In essence, this franchise or business privilege tax is the fee the LLC pays the state for the benefit of limited liability. The franchise tax can be an amount based on revenue, an amount based on profits, or an amount based on the number of owners or the amount of capital employed in the state, or some combination of those factors, or simply a flat fee, as in Delaware.