Should I Form an LLC?

August 12, 2011

This is the question for a growing number of small business owners.  Determining whether to form an LLC, corporation, partnership, or sole proprietorship is always a key decision for the small-business owner.

An LLC (limited liability company) is by far the most popular organization structure for small businesses with the exception of sole proprietorship.

The formation of an LLC provides the same protection as what you would gain by forming a corporation by limiting the liability of the company owners to the assets of the company and shielding personal assets from creditors and most lawsuits.  However, the tax implications of an LLC differ from those of corporations.

LLCs use “pass-through taxation,” which means the LLC does not pay taxes. Income from the business is instead passed down to the company’s owners, who are called members in LLC. They claim the profits or losses on their personal tax forms.  Although an LLC does require a minimum annual fee of $800 paid to the California State Franchise Tax Board, the use of pass-through taxation is one of the largest tax benefits of an LLC.

Once you decide to form an LLC, the accounting paperwork begins.  To officially form an LLC, you will first need to choose a name.  You will also be required to ensure that the name is not currently in use by checking its availability. You will also need to file the LLC-1 Articles of Organization with the Secretary of State and draft an operating agreement.   Although California does not require you to file a written operating agreement, creating one is smart way to get your business off on the right foot.

An LLC operating agreement acts as an internal document that establishes rule and regulations for governing the company along with indicating the company’s management structure.  This means you will need to decide if the company will be “member managed” or “manager managed”.   Member managed is the simplest structure, giving every member (owner) the authority to act on behalf of the business.  A manager managed LLC should only be considered when there are “passive” members in the LLC.  Passive members may be individuals or investors who do not actively manage or otherwise operate the business of the limited liability company.   Finally, the operating agreement should specify how the LLC will be run, how the profits and losses will be split, how major decisions will be made, and how members can be added or removed.

It is always important for owners of small businesses to closely follow tax developments on the federal and state levels with the potential to affect the tax treatment of their particular business entity, including the LLC.  You should always consult your Century City tax professional to with questions about tax advantages of an LLC, and to stay current with tax law changes affecting your business.