How to Form an LLC in 7 Steps

The Limited Liability Company (LLC) has become the most popular business entity choice for aspiring entrepreneurs and small business owners today. An LLC is a hybrid entity that combines the best features of both corporations and sole proprietorships. You get the pass-through taxation of a partnership or sole proprietorship with the limited liability protection of a corporation.

One other benefit of an LLC is that it’s pretty easy to set up. Whether you’re just starting to think about a business plan or you’re ready to file to set up a new business entity, this guide will help you properly form an LLC so you get started on a solid legal foundation.

Why an LLC?

Before you go about forming an LLC, how do you know it’s the right entity for your business? LLCs are so popular these days for a few key reasons.

First, they provide limited liability, which means that the structure legally separates the owner’s personal assets from the company’s debts and liabilities. If the business is sued or racks up debt it can’t pay, creditors generally can’t pursue your personal assets. That’s very valuable protection since most small business owners’ livelihoods are tied to their business and a lawsuit could lead to losing personal assets (like your home) if you’re operating under a sole proprietorship.

Second, LLCs benefit from pass-through taxation. This means the business itself does not pay federal corporate income tax. Instead, the profits and losses of the business “pass through” directly to the owners, who report them on their individual income tax returns. This avoids the “double taxation” that traditional corporations face.

And finally, LLCs are just much simpler to operate than corporations. They have fewer compliance requirements, such as less mandatory paperwork, fewer formal resolutions, and no required annual shareholder or board meetings. You have much more operational freedom.

Step-by-Step Guide to Forming Your LLC

LLCs are formed at the state level, so the process may vary slightly depending on where you register. That said, this guide is generally true across the board.

1. Choose a State for Formation

Typically, you should form an LLC in the state where your business primarily operates. If you form your LLC in one state but primarily conduct business in another, you’ll likely have to register the LLC in the second state as a “foreign LLC” through a process called foreign qualification.

2. Select and Reserve Your LLC Name

Your business name must adhere to state rules and be distinguishable from any other entity already registered there. You can confirm the name is unique and available by checking your state’s Secretary of State (or equivalent) business entity database.

Your name must include “LLC,” “L.L.C.,” or “Limited Liability Company.” For marketing and informal use, you can use a different “doing business as” (DBA) name without the “LLC” designator.

3. Appoint a Registered Agent

Every LLC is legally required to appoint a Registered Agent in its state of formation. A Registered Agent is an individual or company designated to receive legal papers, tax forms, and government correspondence on behalf of the LLC. The agent must have a physical street address in the state of formation and be available during normal business hours. Usually, a Registered Agent is the business’s attorney.

4. File Articles of Organization

Every state’s Articles of Organization (sometimes called Certificate of Organization or Certificate of Formation) may look a little different. Usually, you’ll need to file your LLC’s name and address, the name and address of the Registered Agent, and whether the LLC will be member-managed (managed by all members) or manager-managed (managed only by appointed managers).

Typically, you’ll file the Articles of Organization with your state’s Secretary of State office and must pay a mandatory state filing fee.

5. Draft and Sign an Operating Agreement

Some states don’t legally mandate you to have an operating agreement, but it’s still a good idea to have. An operating agreement serves as the internal governing rules for the LLC, much like a partnership agreement or corporate bylaws. An operating agreement should cover:

• Ownership percentages
• Rights and responsibilities of each member
• Voting power
• How profits and losses will be distributed
• Rules for selling ownership interests or dissolving the company

An operating agreement is essential for multi-member LLCs to prevent future disputes, but it’s also useful for single-member LLCs to further demonstrate separation between the owner the business.

6. Obtain an Employer Identification Number (EIN)

An Employer Identification Number (EIN) is a nine-digit number assigned by the IRS to business entities, essentially acting as the business’s social security number. It’s required if the LLC pays any employees or if it has multiple members. Even if you’re a single-member LLC, however, it’s still a good idea to get an EIN because it’s needed to open a business bank account and to establish business credit. Personally, I’ve opened multiple single-member LLCs and put myself on the payroll, which requires an EIN to file taxes.

7. Check Local Licenses and Permits

Your state filing makes your LLC official, but your local city or county may require additional permissions. Determine any required local business licenses, professional licenses, or industry-specific permits. These could include a general business license for a physical location, health permits for food service, or professional licenses to practice law or medicine.

How to Stay Compliant

Once you’ve formed your LLC, you’re not done. You still have to meet compliance requirements to maintain your limited liability protection. There are a few important considerations to stay compliant.

Open Dedicated Business Bank Accounts

Using business funds to pay personal expenses or vice versa is called “piercing the corporate veil,” and it’s the easiest way to lose your limited liability protection. Opening a dedicated business bank account will help you strictly separate business and personal funds. You’ll need your filed Articles of Organization and EIN to open these accounts.

Understand Tax Obligations

Working with a tax professional is a good idea, but it’s ultimately your responsibility to understand your tax obligations. A single-member LLC is automatically taxed as a sole proprietor and must file Schedule C. A multi-member LLC is automatically taxed as a partnership and must file Form 1065.

LLC’s have the benefit of elective taxation, as well. You can elect to be taxed as an S-Corp or a C-Corp to potentially save on self-employment taxes by filing IRS Form 2253 and receiving an Approval Notice from the IRS. I’ve done this with single-member LLCs because sole proprietorships are required to pay self-employment taxes, which exceed the payroll and business taxes I pay by filing as an S-Corp. It may be a way to reduce your effective tax rate, but always consult a tax professional before making a decision and use an attorney to submit your filing.

Maintain Annual Requirements

To keep your LLC in “good standing” with the state, you must adhere to ongoing maintenance requirements:

• File annual or biennial reports with the state.
• Pay recurring state fees, often called franchise taxes or annual report fees.
• Open dedicated business bank accounts
• Understand tax obligations
• Maintain annual requirements

The specifics of these requirements may vary between states.