llc formation: frequently asked questions about llc formation

Question: Is an LLC, or limited liability company, a corporation?

No, a corporation is a corporation. And you create a corporation by filing articles of incorporation with the appropriate state government agency. People often call this "incorporating."

A limited liability is, well, a limited liability company. You create a limited liability company by filing articles of formation with the appropriate state government agency. If you want to be picky, you don't "incorporate" an LLC, you form the LLC.

Question: What is an LLC, or limited liability company?

A limited liability company is an entity with an identity separate and distinct (at least in the state's eyes) from its owners or managers. The unique identity means that if someone sues the LLC, the LLC's owners don't become liable for the debts of the LLC simply because they own or worked in the LLC. In comparison, the owner of a sole proprietorship and the owners (partners) in a partnership are responsible for the debts of the proprietorship or partnership.

Question: What are Members and Managers

The owners of an LLC are called members. In a sense, then, an LLC's members are equivalent to a partnership's partners or a corporation's shareholders.

The LLC manager thing is a little trickier, but here's how that works. An LLC can be managed by its members, in which case the LLC is called a member-managed LLC.

Alternatively, an LLC can be managed by specifically designed manager-members. An LLC with manager-members will also have non-manager-members who own interests in the LLC but do not have the authority to manage the LLC. You would typically specify whether an LLC is member-managed or manager-managed at the time the LLC is formed. The specific rights and duties of manager-members and non-manager-members would be described in the LLC's operating agreement.

Question: What is an operating agreement?

An operating agreement describes how the LLC will operate and how LLc members will work with each other and with the LLC. In most states, you technically don't need an operating agreement in order to form or run an LLC. But an operating agreement maybe required in some states and by banks.

If you're setting up an LLC with multiple members, you should either get a simple boilerplate operating agreement, oftentimes, you can buy one from an online legal forms site for a few dollars, Or you should confer with a local attorney and have him or her write up an operating agreement that's specific to your situation.

One other comment about operating agreements: If you're setting up an LLC primarily for legal reasons (rather than just for tax reasons), you probably want to get an operating agreement. Especially in the case of single member LLCs, having and honoring an operating agreement is thought to strengthen the liability protection.

Question: What about using an out of state LLC?

Typically, you want to form your LLC in the state in which the LLC will operate. Furthermore, if your LLC does operate in multiple states, your LLC will need to register as a foreign LLC in the "other states" in which it operates or in which it owns property.

Note that this means you can't setup your California business as a Nevada LLC and escape California taxation. Because the Nevada LLC operates /in this example/ in California, it would also need to register in California... and that would mean that California would tax the LLC.

A related point: The idea of setting up a Nevada LLC or Nevada corporation to escape state income taxes doesn't really work unless you move the business and quite possibly your residency to Nevada. Many of the people who do the Nevada LLC or Nevada corporation thing, sadly, don't understand this...

Question: Do limited liability companies work for professionals?

No, usually they don't. However, most states allow professionals to setup professional limited liability companies. The process for setting up a professional limited liability company closely resembles the process for setting up a regular limited liability company.

Question: Do limited liability companies work for real estate investors?

Sure. And lots of real estate investors use LLCs for their investing. Two quick cautions, however: First, consider the possibility that you may get just as good liability protection by just purchasing a bit more liability insurance. Second, if you do decide to use LLCs for your real estate investing, consider using multiple LLCs (such as one LLC per property) so that you have separate LLCs for each real estate property.

Question: What do limited liability companies cost to setup and then to operate?

Limited liability companies bump your business or investing expenses in a couple of ways: First, the states in which you run the LLC require both an initial formation filing fee and then also an ongoing annual re-licensing fee. (You can think about these fees as the "insurance premiums" the LLC pays the state for limiting your risks.) Annual fees vary, but typically run from less than a $100 to more than a thousand dollars. Yikes.

A second expense associated with a limited liability company is the extra financial and accounting costs you'll shoulder. For example, a limited liability company will often be required to prepare and file a more complicated (and hence more expensive) tax return. A limited liability company may pay more for banking and insurance. Finally, you may need to go to more work to clearly identify and show the unique, separate identity of the LLC: new letterhead and business cards, signage, and so on.

Question: Do you need an attorney's or accountant's help when forming a limited liability company?

The states have made LLC formation very straight-forward and easy. Often times, you merely have to send in a simple, one page form. Accordingly, if you're a do-it-yourself type of investor or business owner, you can probably do the formation yourself--and even have some fun doing so.

However, that said, if you think you'll have a lot of questions or if your budget allows for spending perhaps several hundred dollars on an attorney or accountant, you'll probably get excellent value from investing a bit of money on a professional. He or she will not only walk you through the steps, but also provide explanations of how the liability protection works.

Question: What is a registered agent?

A registered agent is just a real person (in other words, a living human being) located in the state in which you formed your llc who agrees to be contacted by the state about the LLC, if necessary.

If you're forming your LLC in the state in which you live, you can be your own registered agent. For very little work, you'll save yourself probably $100 to $300 a year.

If you form a limited liability company in another state, obviously, you need to pay someone in that other state to be your registered agent. An accountant or attorney in that other state, by the way, will often act as your registered agent.