Limited Liability Company (LLC)
Unlike a sole proprietor or a partnership, an LLC is a separate and distinct entity. This means that, as a company, it stands on its own. It has its own tax ID number and bank account. The LLC usually does not, and should not, mix the assets of the company and the owner. The LLC can be organized in two forms. Either the LLC is a pass-through entity, where the owners pay the tax on their personal returns, or like a Corporation where the LLC pays its own income taxes. The default configuration is as a pass-through entity.
Like the partnership, the owners are taxed as the money is earned and not as profits are distributed. If you are keeping the profits in the company in order to finance expansion you must take into account that the individual owners will still have to pay personal income taxes on that profit. Once it is determined that profits are no longer needed to improve the company, profits can be distributed from prior operations. The distributions are not taxable since the income tax was paid on those profits when they were earned.
To form an LLC, you must obtain an employer identification number or EIN which can be used to open the LLC’s bank account. The EIN will also be important when you register the LLC with the State. The formation of the LLC will require that you name a managing member. The manager, the chief operating officer, and all other owners are called members of the LLC. An LLC is required to prepare an operating agreement that will specify the rights and obligation of the Managing member. The agreement will also deal with rules for annual meetings where rules can be changed, procedures for changes in ownership and ultimately procedures for dissolution.
The primary advantage of an LLC is in the limiting of the liability. In most cases, the creditors of an LLC can not collect from the individual owners. Their ability to get judgments and liens are limited to the assets and revenue of the LLC. It provides for the starting and operating of a business without risking the personal security of the owner and their family. To make the limitation work, the owner must not intermingle personal assets with business assets. The vehicles and equipment owned by the LLC must be registered in the name of the LLC. Likewise, the debt securing those assets must be debts of the LLC. If that debt is secured with personal guarantees, then those debts would not be limited to only LLC assets. Your CPA can help you organize your company to give you the best protection.
Even during this time of pandemic there are businesses being formed. In fact, with more people out of work or working from home the starting of new cottage industries are expected to increase. An interesting statistic that I am at a loss to explain is that Hispanic or Latino businesses are being started at a rate of 2 to 1 against any other race right now. What is clear is that online shopping, and therefore selling, is at an all-time high right now. Stay away from those that offer, for a price, to set up online businesses for you. Most of these groups seem to be the only ones that make any money from their arrangement.
This article is for general tax information based on authoritative sources that are subject to change without notice. It is not intended to be advice for your personal use. You should consult a tax professional as your circumstances may differ from those used as an example here. Michael W. Gardner, CPA is available to answer questions about this article at michael@mwgcpa.com or 870-798-2326.