Choosing the Right Legal Entity for Your Startup - Exploring Limited Liability Limited Liability Companys (LLCs)

Before jumping on the limited liability company bandwagon, you must ensure you are eligible to operate as one. Use the list below to be sure that you qualify.

• Members:

  Members can be just about anyone, including individuals, corporations, other LLCs, foreign entities, trusts, partnerships, etc. However, you cannot be a bank or insurance company when forming an LLC.

• Residency & Age Requirements:

  LLCs have no age or residency requirements. Some states don’t even require you to be a legal adult (18 years old).

• Number of Members:

  An LLC can be a single person or many; the IRS does not restrict the number of members.

Limited liability companies offer great flexibility about who can operate as one, making them a very popular option with new businesses.

• Sole Proprietorship:

  If an LLC has a single member, the IRS codes it as a sole proprietorship by default. They call this a “disregarded entity.” The LLC is not taxed as a separate entity; instead, it uses pass-through taxation, where the company’s income/expenses and profits/loss are recorded on the individual’s tax return. The individual will file a Form 1040 tax return and a Schedule C detailing the LLC’s figures.

• Partnership:

  If the LLC has multiple members, the IRS automatically views it as a partnership. Again, the LLC uses passthrough taxation, and members must file the business’s profits and losses on their own tax returns. In this instance, members file a Form 1065 when filing taxes, which is due on March 15th rather than April 15th. Each member must also file a Schedule-K-1 detailing the business’s financial operations and profits/losses.

• C-Corporation:

  When choosing to file as a C-corporation, members must use Form 8832. At tax time, members must file Form 1120. The only thing is when filing as a C-corporation, your net income (after expenses) will be taxed twice. First, the entity will be taxed on profits; then, when you distribute dividends to shareholders, they will get taxed on those (at a lower rate). Although tax rates vary, the federal corporate tax rate is 21%.

• S-Corporation:

  To file as an S-corporation, you must use Form 2553 if your business is eligible to file as such. After that, each member will file Form 1120-S annually. This status allows pass-through taxation and avoids the entity being taxed twice. Each member is taxed according to their own individual tax rate.

Regardless of which tax method you choose, be sure to include its details in your operating agreement so everyone is on the same page.

Limited Liability Companies allow some special deductions that may not apply to other business entities. These are as follows:

• Startup Costs:

  With an LLC, you can take certain deductions on your income taxes. Things like legal fees (when you paid a lawyer to draft your operating agreement and articles of incorporation), filing fees with the state, any market research you performed before going into business, and the development and testing of products are deductible expenses.

• Operating Expenses:

  You can also deduct many of your everyday operating expenses, such as rent, utilities, office supplies, software, and equipment.

• Payroll and Employee Benefits:

  The expense of paying your employees to run the business is another tax deduction you can claim. You may also claim employee benefits.

• Self-Employment Tax:

  You can deduct 50% of your self-employment taxes.

• Home Office Expense:

  If you run the business out of your home, you can take the home office deduction, which reduces your tax burden by a percentage of your home expenses. The percentage equals how much of the building you use for business.

• Marketing and Advertising:

  You can also deduct the cost of promoting your products and services from your taxes.

• Utilities:

  You can deduct the cost of your utilities (phone, electricity, heat, internet, etc.) on your taxes as well.

• Non-Incidental Inventory:

  Inventory, which is crucial to your business operations, may also be deducted from your annual taxes.

Companies evolve and require change. If you started your business as a limited liability company and things change, you may want to switch your corporate entity to another type of structure. Switching from certain types of business entities is more straightforward than switching to others. Some possible reasons for switching from an LLC to a different kind of corporate structure include:

• Liability Protection:

  Each legal structure includes a certain amount of liability protection. If you believe your LLC is not working for you or don’t need as much protection, you can switch to another entity type.

• Tax Advantages:

  LLCs offer some tax advantages, but other entities provide different options. You may be winding down your business and have a smaller footprint; perhaps a sole proprietorship would work better. Other types of entities may help with your self-employment tax burden.

• Attracting Investors:

  If your business is growing and you need to switch entity types to attract more significant, more desirable investors, now might be the time.

• Growth:

  As your business grows, you may want to take advantage of options unavailable to you as an LLC.

• Regulation Compliance:

  Some business entities are easier to manage and comply more naturally with regulations within your industry. Switching may help you with compliance.

• Future Planning:

  As you age, you may want to provide for future generations. That may include restructuring your company so that your kids or grandkids can take over when the time is right.