Ask The Boss Lady’s Lawyer: What is an LLC?
Dear Boss Lady's Lawyer:
What is an LLC? I keep hearing that I need an LLC to start a business. Can you please explain what an LLC is and the benefits of setting one up for a new business?
Curiously,
LL.Confused
Dear LL.Confused:
Thank you for your question! LLCs are easily the most common type of corporate entity that my clients request and come with several benefits in the right scenario.
First, let's start with the basics. What does LLC mean? "LLC" is the acronym for a limited liability company. An LLC is a type of corporate entity that can be used to shield a business owner from personal liability for debts of the business. Ok, lots of legal words. Let me show you with an example.
Nina Baskets loves making gift baskets, and over the past year, she has created a decent client base. She has been operating as a sole proprietor (see our sole prop Q&A here), doing business as Nina's Bountiful Baskets. She reports income with her own social security number. Nina doesn't have liability insurance. Nina designs a beautiful fruit basket for a client snow White. As soon as the basket is delivered, it turns out that the fruit is poisonous! Nina is mortified, and more importantly, Nina is sued by Snow for negligence. Because Nina is a sole proprietor, the liabilities and the profits of her business are hers personally. This means that Snow White can sue Nina Baskets, get a judgment in court against Nina, and then collect that judgment from Nina in a variety of ways. Snow can go after Nina's real estate, her bank accounts, and her wages, subject to certain statutory exemptions from assets liable for collections.
Scary, right?
Now, suppose Nina sets up an LLC - Nina's Bountiful Baskets, LLC - after a few months of growing her business as a sole proprietor. She files articles of organization, obtains a separate employer identification number for tax reporting, and transfers title of her storefront to her LLC. She creates a brand new set of books to account for the LLC's income, sets up a separate bank account, and meticulously ensures that there is no commingling of her personal assets with the business assets. Suppose, again, that Nina inadvertently sends Snow White poisonous apples, and Snow, understandably, sues Nina's Bountiful Baskets, LLC. This time, Snow gets a judgment against the LLC. Here, unless Snow can show reason for a court to hold Nina personally liable for the LLC's actions, Snow will only be able to recover her judgment against the assets of the LLC. Snow can go after the LLC's assets, but Snow cannot come after Nina's home, her personal bank accounts, and her individual assets.
In a nutshell, the above examples illustrate the powers of having an LLC.
An LLC is form of doing business, registered with the Secretary of State, that combines the tax advantage of pass-through tax treatment for income with the limited liability and flexible ownership structure. I know, I know, I've fallen into legal-ese again. Let's break this down:
1. Pass through tax treatment. In some types of incorporated businesses, such as certain corporations, the business entity (X Corp.) has to pay income taxes on income made, and then X's shareholders also have to pay income taxes on income they receive from X corp. With an LLC, you can elect for pass through tax treatment, meaning that the LLC does not itself have to pay income taxes, but the members of the LLC receiving the income will have to pay income taxes, as if it was a partnership, which allows any allocation of income and loss among the members as long as the allocation has substantial economic effect. For example, members who contribute capital to the business can be provided a preferential return, similar to interest. Allocations among members may be determined at the end of the year based on the LLC’s operating results and may also vary from year to year.
2. Flexible Ownership Structure. In an LLC, the folks with an interest in the company are called "members." The LLC can be managed by the members, or it can be managed by a manager who may or may not be a member. A nonresident alien, a corporation, a partnership, another LLC, or any type of trust can be a member of an LLC, and there are no limits on how many members can be in an LLC. Distributions to the members may be flexible. For example, members providing capital may receive a return of their capital before any distributions are made to members who do not.
3. Limited Liability. Remember our friend Nina and her foe Snow? That is an excellent illustration of how liability is limited when you do business out of an LLC. The LLC owners - the "members" - should not be liable for any debts or obligations of the LLC, except in unusual circumstances, when attempts may be made to pierce the corporate veil. Generally, organizing a business as an LLC will protect the members from liability as long as the necessary formalities are observed, such as stringent bookkeeping that is separate from your personal assets and ensuring that all assets of the business and all contracts are in the name of the LLC. Practice Pointer: As most of my clients have heard me say, "Any banana can go into a courthouse and file a complaint against you," in which case you have to defend yourself, regardless of whether the complaint has any merit. Here, the LLC doesn't shield you from paying a defense lawyer an hourly fee to defend your business and your reputation. What does? Insurance. While there are significant liability and tax benefits to reap from doing business as an LLC, liability insurance is what will pay for your legal fees before a judgment even comes up. If you're not ready to incorporate, consider insurance to cover your liabilities in the meantime.
How do you set up an LLC? Certain documents will need to be filed with the Secretary of State, and you will need to apply for an Employer Identification Number. You will also need an operating agreement to dictate the administration of the entity. In Illinois, you will have to pay filing fees that range between $160 - $270 to the Secretary of State (as of 1/8/2020). If you have business property, title of such property needs to be transferred to your LLC. You also need to plan to pay an annual reporting fee, which should be less than $100 (in Illinois as of 1/8/2020) if you pay on time.
In conclusion, I leave you with the following words of wisdom:
I just took her name and made the ***** a LLC
Stuff a couple stacks up in, then ****, get on your feet
You make twice as much if you switch it up, just to see…
Nicki Minaj, “LLC,” Queen (2018)
Queen Nicki's epic flow in "LLC" nails the ease of creating an LLC with precision nearly akin to a perfect haiku. It is as easy as she makes it sounds to just take a name and make your LLC, but running any business, regardless of the form, requires attention to detail and a commitment to organization. Don't set up an LLC if you're not serious about running a business, but if you are serious, then save up enough for filing fees, and take the leap. But, if you do take the leap, get ready to work hard, and - eventually - reap exponential growth.
Don't forget - we are here to help you get in formation. We offer options from guiding you through setting up your LLC in a workshop or handling your formation for you. Just shoot us a note by clicking here and tell us about your vision.
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Until later -
