Are you ready to form an LLC? I’ve seen quite a bit on social media lately about forming a Limited Liability Company to create a business. I want to remind you that not everyone needs to rush into creating one to have a business. It can protect your personal assets from being reached to pay a judgment if it gets sued. There are important decisions to be made about an LLC. Make an informed choice based on where you and your business are at right now.
An LLC has some great benefits. But, it also has some responsibilities that not enough business owners are aware of.
Here’s the skinny on forming an LLC:
Form an LLC: It Creates a New Legal Entity
When you form an LLC, it creates a new legal “person” who will have its own legal identity. You and any partners become “members” of the organization. The organization is the “citizen” of the state where it is formed. Typically in the state where the member(s) live. You are creating a new structure. It needs to be treated that way, even if you are the only member of the business. Depending on where you live you may need to renew your entity each year and file to keep your LLC in operation. Additionally, the LLC will have a separate Employer Identification Number (EIN) for taxes, and you must maintain separate bank accounts.
Form an LLC: All the Business Income Belongs to the LLC
One of the biggest issues I see is that people create an LLC to protect their personal assets, which it can, but they use the LLC bank account as their personal piggy bank. In order for the LLC structure to work, and to protect you, the finances MUST be kept completely separate. The LLC pays you as the owner. Either by a paycheck or through an owner’s draw. You don’t swipe the business debit card to pay personal expenses. Ever. If you do, the courts can conclude that you didn’t actually treat the LLC as a separate person and that you are really the “same person” as the business, so they can go after your personal assets. It’s a little complicated and beyond the scope of this post, but I cannot stress enough how strictly you must keep the finances clean with an LLC.
You May Not See Tax Benefits Until You Reach a Certain Income Level
Another reason to create an LLC is there can be some tax benefits to the business owner. Depending on the tax structure of the LLC, such as an S-Corp, personal income taxes are being paid on the income the owner actually takes as salary or draws, not on the income that is remaining in banks at the end of the year- which belongs to the LLC.
Tax structures and whether the LLC is taxed as a “pass-through” to the member’s personal taxes or as a separate entity is a little outside the realm of this article. But you may be surprised to know that the benefits may not be that great until you pass a certain income threshold. Until your business makes a certain amount in profits, the difference in the amount of taxes may be minimal.
Understand the Benefits AND the Costs
The many companies preparing and submitting LLC documents to the states are either assuming business owners know all the details, or they are focusing so much on the protection they fail to talk about the expense and the upkeep of creating a new entity. In some states, the renewals can be quite substantial. For one of my clients, her LLC renewal is $800.00 a year.
Weigh the costs against any assets that may be at risk, and of course any potential tax savings you could have. Long story short, not everyone needs to rush into an LLC when they first start a business. Talk to a tax professional about any potential tax benefits, and know your state costs and rules before you create your new business entity.
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