Catchy yet original business name chosen – check. State paperwork submitted – check. Operating agreement drafted, reviewed, and signed – check, check, and check. So, now what? What is this new creation you have brought into this confusing world and what are the ongoing requirements and features attached? Read on, you intrepid entrepreneur, you!
Benefits of having an LLC
- Limited Liability – Now that you have officially set up your LLC and are no longer operating as a sole proprietor, arguably the biggest benefit to you (and your partners in success) is the limited liability protection your LLC affords. The best way to understand this is to imagine your LLC as a separate legal “person,” fully controlled by you and the other members (if any). You can transfer business assets to this person and command them to take on debt for the company. If anything goes wrong with your business and someone sues the company, this person would act as your liability shield, and defend and protect your personal assets (house, car, personal bank account, vintage beanie babies collection) from the person suing your business. The limited liability protection means that if you were to lose the lawsuit, you would only lose the value of what you have put into the company, regardless of whether the judgment exceeded the value of the company’s assets. Conversely, as a sole proprietor, you face “unlimited” liability in that, if someone won a lawsuit against your business, they could grab almost any of your personal assets in order to satisfy the judgment. However, you must be careful not to mix your personal assets with the business assets of the LLC (especially bank accounts) as this may allow a court to pierce this limited liability shield and access your personal assets to satisfy any judgment against you.
- Taxation – On the tax side of things, an LLC allows you to avoid the double taxation headache some corporations face. We’ll try to keep this simple, as we understand that it is a hugely boring area of the law. A regular corporation (i.e. one that has not made an S-Corp election) is first taxed on its annual earnings (i.e. on money coming into the business), and subsequently the shareholders are taxed on the dividends they are paid out from the corporation (i.e. on money going out of the business to the owners). LLCs, on the other hand, allow you to skip the first tax and only be taxed at the individual level. If you opt for this tax structure, all members must report their share of the LLC’s income and/or losses on their personal income tax returns, even if no money is actually paid out to them during the year. For more tailored advice on this topic, you should consult a CPA (hey, we can do a lot but we can’t do everything…yet).
- Credibility – Now that you have formed an LLC you have taken a huge step towards heightening your credibility with potential investors, employees, customers, suppliers, and partners because you have made a formal and significant commitment to your business. An LLC structure, while not as attractive to larger institutional investors as a corporation, will make it easier and more appealing for smaller investors to invest in you because they will not be putting their personal assets at risk by giving you their money (see, Limited Liability above).
- More Flexibility, Less Compliance – LLCs have the freedom to establish any organizational structure that its owners agree upon. Unlike traditional corporations, which must be managed by a board of directors (the managers) separate from its shareholders (the owners), an LLC can be managed by its members (the owners) without risking its limited liability shield. Furthermore, LLCs face fewer state-imposed annual requirements and ongoing formalities than corporations. For example, unlike with corporations, there is no requirement that the LLC’s members meet once a year for an annual meeting, or file an annual report with the state. Essentially, with an LLC there are fewer things to forget to do every year, which means there is less of a chance that you might accidentally and unknowingly jeopardize your LLC’s good standing.
California imposes a minimum LLC franchise tax of $800 per year, and adds to this an LLC fee on a sliding scale for all LLCs making more than $250,000 in one year. Thus, if your LLC makes less than $250,000 in a year (even if it makes $0 or a loss for the year) the minimum you will have to pay per year is $800. See here for a chart detailing the sliding scale of LLC fees for LLCs making more than $250,000 per year.
California’s taxes are in addition to, and separate from, any taxes imposed by and payable to the IRS. Taxes owed at the federal level are completely dependent on how you choose to structure your LLC for tax purposes (i.e. as a disregarded entity, a partnership, or a corporation) and are beyond the scope of this article. You should ask your CPA about what tax structure is right for your business.
Additionally there may be local county taxes to pay. If you are located in California, each County requires businesses operating within its area to obtain a Business Tax license (or an equivalent) and pay annual taxes to the County. These taxes vary depending on the type of business you are engaged in, and there are some exceptions to the tax (e.g. Los Angeles County exempts small businesses with annual gross revenues of less than $100,000; however, unfortunately, film production companies are explicitly excluded from this exemption). This website provides useful links for all state required business licenses and permits.
Opening a bank account
Usually the second major step after you form your LLC at the state level is to open a bank account in its name so that your business can get paid for all of your hard work. Opening a separate bank account for your LLC is also vitally important for you to keep your limited liability shield because a court may satisfy a judgment from your personal assets if you mix your personal and business assets, for example, if you pay for business expenses with your personal checking account or vice versa. Below are the basic steps for setting up a bank account:
Step 1 – Decide on the kind of bank account, or even combination of accounts, that is right for your LLC to conduct day-to-day business. Many people opt to bank with the same bank they use for their personal banking, which is fine to do. However, you should visit your bank’s website to see what it offers for small businesses, and then compare your bank to other banks. For each bank, some things you may consider are the amount of bank fees, online banking functions, overdraft protection, interest, check-writing and cashing capabilities, and minimum balance requirements. Pick one that suits your LLC’s banking needs. If you have other partners, each member’s preferences should be taken into account when you make this decision.
Step 2 – Before heading in to the bank, call a banker at your chosen institution and ask what specific documents and verifications are required to open an account. Banks sometimes have different requirements, but generally before any bank will open an account in the name of your LLC it must verify the following to comply with U.S. banking regulations:
- That your business is active and properly registered as an LLC with the proper state authorities,
- That the name of the business is what you are claiming it is,
- The tax identification number (EIN) of the business,
- The individuals who will act as authorized signers of any account.
Step 3 – Gather all documentation that the banker told you was required. Most often these documents will be a combination of your LLC’s Articles of Organization, Operating Agreement, business license, and EIN Letter. If we are your attorneys we will have provided these documents to you (or will be providing them in the next week or two when we get them back from the Secretary of State), but if your bank needs anything further, we can work with you to secure the additional requested pieces.
Step 4 – Meet with the banker at your chosen branch and open the LLC’s bank account. The member(s) of the LLC generally act as signers of the account. If the LLC’s operating agreement does not indicate who will act as an authorized signer or detail who has the right to withdraw funds, you should assign those rights in your operating agreement before you meet with a banker and open any accounts. The designated signers should bring the required documents to the meeting, including personal identification such as a driver’s license or state identification card.
Your Operating Agreement
The LLC’s Operating Agreement is its constitution. However, unlike the Constitution, it is far easier to change, amend, and update to better reflect the current affairs and operating status of the organization. If we are your lawyers, we have provided you (or will be providing you) with the baseline for your LLC’s Operating Agreement. This document contains the basics to help you stay legally compliant and provides a roadmap should anything go awry with your LLC or the other members. But every LLC is different, and so you should read through this document and flag any section you feel does not accurately reflect how you intend to do business. Some sections are, unfortunately, heavy on the legalese, but this is based on best practices in the industry. Likely, you will not need to use these sections unless something seriously wrong occurs, at which point you will likely have hired helpful professionals to interpret these provisions for you (wink wink).
SPAM Warning: Labor Law Compliance Notices
Due to the fact that your company’s name and address is now publicly searchable, unscrupulous companies will send you unwanted SPAM mail. Often these notices will look scarily official and will demand that you pay a certain amount by a given date or face penalties. In California and New York, the most common of these letters concerns Labor Law Compliance Posters, which businesses must post at their workplace when they hire their first employee (so, note that until you hire your first employee you are not required to post anything, regardless of what some notice with typos might tell you). California Labor Law notices can be downloaded for free here, and must be printed and posted in a conspicuous location. The same requirements apply for New York Labor Law notices, which can be downloaded free here. Alternatively, if you want a more professional looking poster, a simple Google or Amazon search for your state’s poster should deliver cheaper results than any notice you will receive in the mail.
By: Kieran de Terra, Esq. – 07/07/16
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