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Table of Contents Understanding Your Options............................. Entity Comparison Chart................................ Limited Liability Company s Quick Review.................. The Players In An LLC................................. Ownership Of An LLC.................................. Management Of An LLC................................ LLC s Can Be Taxed Four Different Ways.................. Flexibility Distributions................................. Compliance Requirements............................. Single-Member LLC................................... Why Would You Use An LLC............................ When Should I Form My Company........................ What Name Should I Use............................... Where To Form An LLC................................ The Importance Of Doing It Right......................... About Laughlin Associates.............................. Get Started.......................................... Page 1 Page 2 Page 3 Page 4 Page 4 Page 5 Page 6 Page 8 Page 9 Page 11 Page 12 Page 15 Page 15 Page 15 Page 16 Page 17 Page 17
Understanding Your Options As a business owner, you need to protect both your business and personal assets. The best way to do that is by separating them from each other. Typically, it is best to place your business inside a formal entity such as a Corporation, Limited Liability Company or Limited Partnership. This type of strategy can provide greater asset protection, tax advantages and estate planning options, all of which will help you throughout the life of your business. Whether you are in the process of starting a company or if you have been in business for a number of years, making the decision to incorporate or form an LLC is an important one and can sometimes become confusing. In choosing the right business entity you should ask yourself a few questions; How easy is the structure to set-up? Who controls the structure? What are the levels of liability? What are the tax consequences? Where, when and how to get started? 1
Comparison Chart To truly make an educated decision on which entity is right for you we have included a brief description of a Corporation, Partnership, and S-Corporation along with an extensive explanation of a Limited Liability Company (LLC). 2
Limited Liability Company s Quick Review A Limited Liability Company (LLC) is a hybrid between a Corporation and a Partnership. An LLC provides the liability protection of a Corporation with the passthrough taxation of a Partnership. Limited Liability Companies are becoming popular due to their flexibility in management and the personal liability protection offered to their members. While LLC s don t provide many of the same fringe benefits as a Corporation, the flexibility and simplicity of ownership make it the ideal tool for a small company looking for liability protection. 3
The Players In An LLC LLC s are made up of members who act in similar capacity to shareholders in a Corporation. Anybody can be a member of an LLC, unlike an S-Corporation which limits the type and number of shareholders. In fact, a Corporation can even be a member of an LLC. There can be one-member or multiple-member LLC s, it s really up to you. Ownership Of An LLC The members buy interest in the LLC in exchange for cash, property, services or the promise of payment. In exchange for their investment the members receive ownership interest. In most cases the investment of cash is not a taxable event. In the case of property, services, equipment or promise to pay there are tax issues that should be looked at. 4
Management Of An LLC If the LLC is managed by its members, then it is considered member managed. If the LLC chooses to hire an outside manager or designate the position to a member, then the LLC is considered manager managed. This is something you will have to determine prior to filing your new LLC. If you are planning to only allow a few people to participate in the LLC and you are all on the same page, then you might want to look at having the LLC member managed. If you are operating multiple ventures out of one company with active and passive investors, then you might be better off hiring a professional manager or electing an active member to be the manager to avoid any unnecessary conflict when it comes to decisions made by the LLC. 5
LLC s Can Be Taxed Four Different Ways This is where people get a little confused. It s hard enough to understand personal taxes let alone four options with LLC s. One thing to clarify is no matter which way you choose to tax the LLC, you still - I repeat - still maintain the same level of liability protection. This is a taxing issue, not a liability issue. 1.) If you are a single-member LLC then you will be taxed as a Sole Proprietorship unless you designate to be taxed as a Corporation with the IRS. As a Sole Proprietorship the money will flow to you directly and you will be required to pay self-employment taxes. If you run an active business, which means you are actively working to obtain the money, then you will be required to pay self-employment tax. If you are using the LLC to hold property and the money is coming from passive income, then you will need to file a Schedule E with the IRS. 2.) You can also elect to be taxed as a Partnership. Of course this would mean you have a partner in the business. This is not a selection that is used very often because you are required to pay self-employment tax on any income that is passed on to you from the business. 6
LLC s Can Be Taxed Four Different Ways (Cont.) 3.) The third option is to be taxed as a Corporation. If an LLC wants to be taxed like a Corporation you will need to file form 8832 with the IRS. In this case the LLC would file its own tax return. If the LLC/Corporation has members who are paid employees, then the LLC is responsible for payroll tax. It s always a good idea to use a professional payroll service for your employees. The penalties for doing this wrong are costly. 4.) The fourth option is to be taxed as an S-Corporation. The profits and losses pass through to the members. Being taxed as an S-Corporation allows you to split income by paying employee owners a wage that is subject to payroll tax and then paying out a dividend on profits taxed at the dividend rate. This is important in tax planning because you can adjust your tax bracket based on how you pay yourself. Of course you will need to make sure the wage you receive is based on reasonable compensation for your job description. When an LLC doesn t make an election, the IRS will automatically tax the entity as a partnership, which means all the profits and losses will pass through to the member s personal income tax. If you are switching from a sole proprietorship or a partnership, then you are already receiving pass through income, so there would be little change in the way you currently file your taxes. The thing to remember is no matter what designation you choose with the IRS, you still maintain the liability protection provided by an LLC. The tax selection is only for the IRS and/or state taxing authority. 7
Flexibility Distributions Another benefit to having an LLC is the flexibility in distributing profits and losses to the members. Distributions of the LLC can be based on the total amount of membership interest each party has. It can also be based on the amount of work they put into the company, or a number of other flexible distribution formulas. Example: If you started a computer programming business with a partner and you contributed all the capital, and your partner was the brains behind the programming but didn t have any money, you might decide to allocate a greater percentage of the distribution to yourself for a few years until you receive some of your investment back and then reevaluate the situation. 8
Compliance Requirements There are many misconceptions about the need for paperwork and LLC s. It s imperative that you keep documentation on the actions of the company; it doesn t matter if it s a Corporation or LLC, the requirements are the same. Anytime you go into business you will be required to keep formal documents. You must maintain minutes, resolutions, annual filings, tax returns, quarterly statements, employment agreements, operating agreements and local and county licenses. To put it into perspective, you must document in order to defend. What this means is when you are involved with partners, divorce, litigation, loans, contracts, creditors or anytime your business is challenged, you must have the documentation to prove that you were treating your business as a separate entity. The burden of paperwork is not something that can be overlooked. It s the only thing that establishes the liability protection of your LLC. It s the only thing that proves you are treating the LLC like a real business. 9
Compliance Requirements (Cont.) All Corporations and LLC s are required to maintain ongoing compliance requirements. Don t make the critical mistake of thinking that when you form an LLC you are exempt from meeting these requirements. Failure to do this will leave you personally open to exposure, creditors, litigation and IRS audits. Members are allowed to review records at any time, so when there is a dispute between members, spouses or partners, then you want to make sure every transaction has been approved. The LLC is only as strong as the documentation backing it up. Do not think for one second that you will not be required to prove you are treating the LLC like a real business. If you don t think you can manage this part of the business, then hire somebody to do it for you or don t form the LLC. It s that important. Running a business is risky, but you can control the risk when you shield your personal assets from attack. The only way to do this is by using a Corporation or LLC, but you must meet the legal requirements to maintain the legal shield these companies provide. This cannot be emphasized enough; LLC s Are Required To Keep Records! 10
Single-Member LLC A single-member LLC means exactly what the term implies. There is one person who is the owner. A husband and wife are also considered one member. LLC s were generally designed to reduce the risk between partners. If one partner was to lose his/her membership interest due to creditor or litigation, then the other partner wouldn t be stuck with an unwanted partner. If you have two members and one member was to be sued by a creditor and lose his/her ownership interest in a legal battle, then the remaining partner would not be forced to take on a new partner. The person that won the membership interest would only be allowed to partake if the LLC was to issue a dividend on the profits. This is called charging order protection and is a powerful deterrent. Since LLC s are so new, the case law on single-member LLC s is still being worked through the courts. If an LLC was designed to protect partners, then in the eyes of the law, there isn t really anybody to protect if there is only one owner. So you have to be careful if you are a single-member LLC. In some cases you might want to look at taking on another member. You can use another Corporation to hold membership or you can give a small percentage of ownership to another person. You can protect your ownership and rights to the company when you put together your operating agreement. A husband and wife are still considered one member in the eyes of the IRS. Another misconception that can cost you everything is thinking that just because you are a single-member LLC you aren t required to meet the same legal requirements as the big guys. In the eyes of the law they don t care how many people are involved. In fact, you are even scrutinized more because in most cases they know you aren t doing the paperwork. 11
Why Would You Use An LLC? There is no one-size-fits-all when it comes to who can and can t use an LLC. Due to the flexibility in structure and taxing, LLC s fit for most businesses with a few exceptions. In some cases, depending on the type of profession you are in, you could be restricted from forming an LLC. If you aren t sure, please call 1-800- 648-0966 and we can do a search to see if you are eligible. Here are just a few examples of how an LLC was used for different scenarios. Real Estate Example: Let s say you want to buy some rental property, but you know how risky it is to have tenants. So you decide to form an LLC and have the LLC buy the property. This prevents you from being held personally liable if the LLC was ever sued. Real Estate Example: You already own a Corporation, but you want to buy some property personally that the company might be using in the future. So you form an LLC and have the LLC purchase the property. In a few months the Corporation decides it needs that property to expand, so the Corporation leases the property from the LLC. This allows you to sell the property in the future without having to pay the additional tax generated by selling a piece of property in a Corporation. Real Estate Example: John is a W-2 employee who, along with some family members, has decided to start an investment club. They have decided to pool their money and buy real estate, stocks and maybe some options. They did some research on which business entity would suit their needs and in the end they decided on an LLC. 12
Why Would You Use An LLC? (Cont.) Consulting Service Example: A small group of family, friends or business associates decides to start a small consultation firm. Instead of forming a partnership which adds risk to everyone involved, they decide to form an LLC. This provides limited liability to everyone. In addition, some people are buying ownership with cash while others are going to be providing their services. Since they can adjust the distribution anyway they want, they can say the people who contribute cash are going to get a higher percentage of distributions than the people who are committing services. All the members wanted to have a say in the investments the club would participate in. An LLC allows for the flexibility in management they are looking for. It is also easier to transfer assets in and out of an LLC vs. a Corporation. With a Corporation you run into a capital gains issue when you sell property. Because an LLC can be taxed as a pass-through entity, you can greatly reduce your capital gains. Software Development Example: Susan had invented a proprietary software program that allowed people to search the internet twice as fast. She knew it would be a few years before she would actually sell the software to another company as she was still working out the kinks and wanted to make sure she got the right deal. So she decided to place the patent in an LLC which allowed her to plan for future tax saving benefits. 13
Why Would You Use An LLC? (Cont.) Due to it s relatively inexpensive start-up costs and ease of management, the LLC serves as a great tool for holding real estate, trademarks, patents, and other assets. LLC s are also great tools for small operating businesses. While LLC s don t provide some of the same fringe benefits as a C-Corporation, the flexibility and simplicity of ownership make it the ideal tool for a small company looking for asset protection. Not all businesses can operate as an LLC. Businesses in the banking, trust and the insurance industry, for example, are typically prohibited from forming an LLC. Some states have their own restrictions on who can form an LLC. In California, architects, accountants, lawyers, doctors and other licensed healthcare workers are prohibited from forming an LLC. *This information is for general purposes only. All that we do is submitted and performed with the understanding that we are not engaged in rendering legal, accounting or other such professional service. If legal advice or other expert assistance is required, the services of a professional should be sought. 14
When Should I Form My Company? If you operate a business, even a home-based or part-time business, or if you are thinking of starting a business, then the time to form an LLC is now. What Name Should I Use? When you pick a company name you will have to make sure it s available in the state in which you are forming the company. If it is similar to another business name or includes certain restrictive words, then the state will reject it. Many people form a company and then use a DBA (doing business as) to brand certain products or services, so don t panic if the original name you wanted isn t available. Where To Form An LLC? Most people choose to incorporate in the state in which they do business. Some people choose a state with more favorable case law or tax benefits like Nevada, Wyoming or Delaware. The important thing to remember is that you are making a decision to subject yourself to the law of the land you choose, and you will need to be vigilant, aware and knowledgeable as to the requirements of that state. 15
The Importance Of Doing It Right Not only is it important to pick the right business structure, but it s even more important that you set up your new company right from the beginning. Failure to structure your business correctly from the start can leave you personally exposed to RISK such as litigation and possible tax penalties. We ve all heard the saying, if it sounds too good to be true, it probably is. Well, the same holds true when you re shopping around for a company to assist you in forming a new Corporation or LLC. Many companies only promote their fees; they don t inform you about the state fees. Many times the fees imposed by the state are more than the formation fees. Signing the state documents without paying these state fees could result in a felony and your company operating under false pretenses. At Laughlin Associates we have one philosophy; make sure the client does it right from the beginning. Not only do all our corporate programs include the filing fees, but we will assist you in completing all of your initial LLC documents. 16
About Laughlin Associates Laughlin Associates has trained consultants ready to help you take the next step. Our service doesn t stop once you form your company. We are here to make sure you get your questions answered and keep your company on the right track every step of the way. At Laughlin Associates we don t sell products, we provide solutions. We will work closely with you to make sure your company is formed correctly. So before you take the next step, ask yourself one question: If I can t afford to do it right, should I be doing it at all? Laughlin Associates has been assisting people just like you since 1972. We pride ourselves on complete customer service and a professionally trained staff. With the experience gained by assisting over 77,000 companies, Laughlin Associates is the company with the know how to get you started right. Get Started In Just Three Easy Steps, You Can Secure Your Future! 1.) Choose the name of your LLC. 2.) Call 1-800-648-0966. 3.) Congratulations! Your Own Company, LLC. 17