What is an LLC?
LLC is an abbreviation which stands for ‘Limited Liability Company’. This is specifically a United States based form of a company in the private sector. An LLC exhibits the properties of both a corporation and a partnership but is neither of them. The number of owners determines whether it is treated as a partnership or a sole proprietorship.
Features of LLC
LLC, like a corporation, gives its owners limited liability and the availability of flow-through taxation to all the co-owners. An LLC, when established, is ”organized” and the founding document of an LLC is referred to as the “articles of the organization”. An LLC is governed under an operating agreement.
If you want to open an LLC, we’ve provided the information that you need to decide if it makes sense for your business and a step-by-step process for how to establish an LLC in the state of Delaware.
So, why pick an LLC?
Here are the advantages:
As compared to other types of business, Limited Liability Companies require less paperwork. Handling the paperwork and keeping it safe is not an easy task and there is a high risk that important paperwork might get misplaced or damaged. There are less stringent compliance requirements, reducing the amount of paperwork you need to file annually. For examples, corporations require regular board meetings with minutes of the meetings logged – LLCs don’t have these requirements. The bare minimum of filing requirements generally amounts to an annual Statement of Information and not much else.
Another feature that is a major reason why people opt for this type of business rather than other forms is tax flexibility. The Internal Revenue Service (IRS) does not consider LLC a separate body for the purpose of taxation; so the IRS does not impose taxes on an LLC directly, it depends on how the members of an LLC opt to pay the taxes. LLC members have three choices for the payment of the tax.
- LLC as an S-Corporation or C-Corp: the LLC can choose to elect themselves as a corporation and pay taxes the way a corporation does. This must be elected by filing with the IRS (generally within 75 days of establishing your LLC).
- Partnership: This is the default for multi-member LLCs and the IRS does not view the LLC as a different entity than the partners (for tax purposes). That means the partners get pass-through taxes – that is to say, they pay as if it’s their own income.
- Single Member LLC: the default for single member LLCs. Taxes are imposed as a single member’s personal federal tax return.
All this is decided at the initial stage of the establishment of an LLC.
As the name suggests, this form of business provides limited liability to its members. Just like corporations, members of an LLC are not held liable for issues such as debt, court judgments, and other legal issues that may come up while doing business. The greatest advantage of an LLC is that the creditors cannot go through the personal assets of the LLC members to recover their amount, so if you take a loan out in the LLC’s name, but can’t pay it back, the bank cannot come after your personal property. Do keep in mind, for young LLCs, banks will often ask for a personal guarantee when taking out a loan. That means that you basically act as a co-signer to the LLC and the bank CAN come after you to collect on the loan if the LLC is not able to pay. This advantage, however, is not available in a business partnership or sole proprietorship.
These three reasons make LLCs preferred for new businesses that prefer to stay lightweight with low filing requirements but still want the limited liability offered by organizing.
However, not everything is perfect and there are disadvantages too.
The Disadvantages of an LLC
Unlike a corporation, if any of the members decide to leave an LLC, the LLC has to be shut down. It is not easy to add or remove members. A corporation stays intact even after some of its shareholders decide to part their ways. Neither the profits nor the working of a corporation is hindered; for an LLC, you have to shut down and reorganize as a new LLC.
Like we discussed in the tax payment methods of an LLC, the members of the LLC have three choices. They can either register themselves as a single member LLC, a partnership or a corporate. In both cases, a single member LLC or a partnership, the owners are subject to self-employment taxation. This type of taxation is higher than that imposed on a corporate. In the self-employment taxation, each member of an LLC is subjected to pay for expenses like Medicare and Social Security, etc.
There are specific designations in a corporation such as employees, managers, directors etc. Unlike a corporation, there can be some confusion regarding the roles of members of an LLC. Because there are no specified designations or roles in an LLC, the terminology and roles can be confusing. In the operation agreement (part of the articles of organization), you can specify roles and responsibilities. But you don’t have to, so if the LLC is small and you already know who’s doing what, you can skip being explicit.
A major part of these highlighted disadvantages can be overcome during the initial stage, when the operating agreement is written.
How to Legally Establish a Limited Liability Company in the State of Delaware:
Since we have already discussed what an LLC is, its advantages and disadvantages, and why it could be preferred over other forms of businesses, let us discuss the various steps required to legally establish an LLC.
Here are the major steps you must carry out in order to legally establish an LLC.
Coming up with the perfect name for your LLC:
The first step of establishing any business, including an LLC, is to come up with an appropriate name for it. Proper care must be taken about some rules that are set to name an LLC in Delaware:
- Make sure that the name you come up with is not associated to any other LLCs in Delaware. You can search available names here.
- The name must end with “Limited Liability Company” or “Limited Company”.
- If there are any words prohibited by the state of Delaware for an LLC, make sure the name you come up with does not include those words. You can find the statue here under “18-102 Name set forth in certificate.” Basically you can’t have “bank” in your name unless you are a bank.
- Make sure the name selected does not violate any other company’s trademark.
Articles of Organization:
Just like a corporation writes its articles of incorporation, members of LLC have to write the articles of organization. After the name has been selected, you must head towards the Delaware LLC filing office to set up your articles of organization. In the state of Delaware, this document is called as Certificate of Formation and . This certificate must include the selected name and information of the registered agent of the LLC (name, address etc). This step is important and the filing fee of this document in Delaware is $90.
You can fax the document to: 302-739-3812
Or mail it to:
Division of Corporations
John G. Townsend Building
401 Federal Street, Suite 4
Dover, DE 19901
Make sure to include all fees with your application.
The next step you need to do to establish of an LLC legally is to appoint a registered agent (like us!). It is a requirement in Delaware that every LLC must have an agent for service of process. This agent is someone who accepts the legal papers in case of any problems on behalf of the LLC. The agent must have an address of Delaware. If you live in Delaware, you can be your own registered agent, if you don’t you need to have one.
We’d love to be your registered agent – click here to sign up!
The Operating Agreement:
Like every corporate has bylaws by which it is governed, an LLC has an operating agreement. Though it is not a necessity in Delaware, but is highly recommended. If you decide to establish an operating agreement, you must know that this document has to be filed in the certificate of formation you designed earlier.
Fulfillment of Basic Requirements:
After all the above steps have been completed, you must comply with the tax and regulatory requirements. These requirements include:
- Employer Identification Number: if your LLC is not a single member LLC, each member must head to Internal Revenue Service for obtaining an Employer Identification Number (EIN). If it is a single member LLC, you must still obtain an EIN number for it, irrespective of employees. You can apply for an EIN on the IRS site here
- Business License: like every other business in Delaware, your LLC must also obtain a business license depending upon the nature of the business and its location.
- State Tax Obligations: in the state of Delaware, every LLC must pay an annual amount of $300 by 1st June of every year. This is called the Alternative Entity Tax.
Elect a tax classification
Like mentioned above, LLCs have flexibility with their tax status. But – you have to make sure you elect your tax status with the IRS (by filing IRS Form 8832). Otherwise the IRS will select a default tax status that could cost you significantly at tax time. The default tax status are “sole proprietorship – self-employed” for one person LLCs and partnership for multiple member LLCs. So if you want to take advantage of S-Corp tax status, make sure you file the paperwork!
Good luck with your LLC!
Delaware Name Search: https://icis.corp.delaware.gov/Ecorp/EntitySearch/NameSearch.aspx
Delaware LLC Naming Statute: http://delcode.delaware.gov/title6/c018/sc01/index.shtml
Delaware Filing Resources: http://corp.delaware.gov/newentit09.shtml
LLC Filing Paperwork: http://corp.delaware.gov/LLCFormation.pdf
IRS Corp Entity Tax Type Election 8832: https://www.irs.gov/pub/irs-pdf/f8832.pdf