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How to Start an LLC

Geoff Williams

If you've recently started a small business, at some point, somebody -- probably your tax preparer or accountant -- has likely asked: "Do you want your business to be an LLC?"

A limited liability company, or LLC, is a way of classifying your business to the Internal Revenue Service, and there a variety of perks and tax benefits available to LLCs. "LLCs are the most popular form of business entity today because they generally provide more asset protection than a state law corporation, have less state law required corporate formalities and are more flexible for choosing a tax classification," says Whitney Sorrell, a tax attorney who owns Sorrell Law Firm, PLC, in Scottsdale, Arizona.

If you're unsure whether or not you should form an LLC -- and where to begin -- here's a primer on getting started.

[Read: Best Small Business Apps.]

Should I Form an LLC?

When creating an LLC business structure, you have a number of options. You can list yourself on your tax-filing as a sole proprietor, which involves no special paperwork, or your company could become an S-Corp or a C-Corp. Few small businesses form a C-Corp due to its complexity in rules, fees and paperwork, according to Brian Cairns, CEO of ProStrategix Consulting, a business management consulting firm in New York City. "Most form either an LLC or an S-Corp," Cairns says.

Plus, if your business takes off, and you're extremely profitable, you can create an LLC, S-Corp or C-Corp later on. Keep in mind, however, it is more difficult to turn a C-Corp into an LLC or S-Corp without unfavorable tax consequences.

The Benefits of Forming an LLC

There are several advantages of forming an LLC over, say, remaining a sole proprietor. A major benefit is limited liability. If something goes wrong, and you are sued, your personal assets would have more coverage from being taken by creditors. Granted, you may have a business that isn't likely to hurt anyone and come to the conclusion that you don't need to form an LLC. But "if your product or service is something that touches people, involves consuming food or beverages or involves kids, then you should absolutely have a business entity set up because the liability risks are high," says Craig DuFord, co-founder of DuFord Law, which specializes in business law and is based in San Diego.

"I'd also recommend this to an entrepreneur with multiple businesses. Without a separate entity for each one, a lawsuit from one can reach into your other ventures," DuFord says.

Another bonus of forming an LLC is less paperwork than when filing as an S-Corp or a C-Corp. Still, there is documentation, such as possibly having to file annual reports, associated with LLCs. With an LLC, you'll also have added flexibility. If you have a corporation, there are more rules, such as needing a board of directors to develop policies and make sure they're carried out. Ultimately, LLCs offer more freedom in how the business can be run.

[Read: How to Start a Business From Home.]

The Tax Implications of Forming an LLC

With an LLC, you may be eligible for additional tax benefits. According to Cairns, the LLC is considered a pass-through entity for tax purposes, "meaning any profits or losses are directly passed through to the owner, partners or shareholders as income."

If your business loses money, often your tax burden would be considerably less if you're simply a sole proprietor. But regardless of your financial situation, you'll still pay taxes as a business owner. Still, every business is different, and the rules involving LLCs in each state are different. "A well-informed tax lawyer is best suited to explain options and guide your choices," Sorrell says.

How to Form an LLC

There are several steps you'll want to take to form an LLC. First, you must select a business name and file paperwork, usually called articles of organization. You'll also create an LLC operating agreement, which states the rights and responsibilities of the LLC members. You may also need to publish a notice of your intent to form an LLC. Finally, you may have to apply for licenses or permits for your business.

You can do all of this on your own, and there are a number of websites, such as LegalZoom, Rocket Lawyer and MyCorporation, that help business owners file the necessary paperwork. You might also want to hire a tax attorney or a certified public accounting firm.

As for how much it costs to form an LLC, budget several hundred dollars. If you hire a tax attorney or a CPA, you might spend hundreds or thousands of dollars. If you use a DIY legal website, you'll pay considerably less. MyCorporation, for instance, currently charges $99, plus state fees to set up an LLC. Meanwhile, LegalZoom charges between $79 and $349, depending on the services you get, plus state filing fees.

State fees will vary. In Arizona, for example, you'll pay $50 to set up an LLC. In Alabama, you must pay $183, in Kentucky, you must pay $40 and in Massachusetts, the cost is $500.

[See: 8 Big Budgeting Blunders -- and How to Fix Them.]

Other Considerations Before Forming an LLC

It's important to understand some of the intricacies of forming an LLC. Sorrell points out that if you follow the rules, hold annual meetings and keep your paperwork up to date, it can help if you do happen to be sued or if, for instance, you were audited by the IRS. Simply forming the LLC doesn't really provide much benefit unless you install an operating agreement, hold annual meetings and pay attention to details, Sorrell says. One detail to consider is if you would need to pay unemployment compensation to yourself, which is unnecessary as a sole proprietor. Also, keep in mind, some banks may charge higher fees for LLCs than sole proprietors. To stay on top of LLC documents and easily navigate the process of setting up an LLC, consider turning to a trusted tax attorney or CPA.

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