- Starting a limited liability company (LLC) is a popular way to make a small business official, giving it legal separation from its owners.
- Filing an LLC can give you flexibility with taxes, shield you from personal liability, and make your company more legitimate for customers. It may also make it easier to get small business loans.
- Learn how to start an LLC — and why it’s different from a sole proprietorship — in this step-by-step guide from Nav’s experts.
What Is an LLC?
A limited liability company, or LLC, is a business structure that is regulated by the secretary of state in each U.S. state. Different states have different rules for starting an LLC, including different filing fees, registration requirements, and more. Business owners who choose to file as an LLC enjoy liability protection for their personal assets — meaning they can’t be held liable for the business’s debts.
Forming an LLC can be a good idea because it’s easy to set up, cost effective, and simpler to maintain than other business structures like S corps or C corps. If you’re interested in LLC formation for your new business but don’t know where to start, that’s where Nav comes in: Follow our guide below.
Why Start an LLC vs. Sole Proprietorship?
Many small business owners who work for themselves or don’t have employees choose to act as a sole proprietorship (or sole prop). This means that they’re operating without forming a separate legal entity. Generally, they don’t file any paperwork unless they need industry-specific licenses.
There are many differences between a sole prop and an LLC, but the main difference is the amount of liability protection afforded to the business owner. In an LLC, the owner or owners are not liable for the debts of the company, meaning that a creditor couldn’t go after their personal assets, including their car, home, or personal money.
There are a few other pros and cons of owning an LLC over a sole prop.
- Liability protection against commercial debts and some lawsuits
- Increases your credibility for customers
- Makes it easier to get small business loans or other financing
- Can choose tax structure and how your tax returns are handled
- Enjoy self-employed tax benefits
- Can help you build your business credit
- Need to know state paperwork and licensing requirements
- Have to pay annual state filing fees and industry licensing fees
- May be required to pay state business taxes and unemployment taxes on top of federal, state, local, and self-employed income tax and other employment taxes
- Might cost more to complete a tax return for an LLC than a sole proprietorship
Before Filing an LLC: 7 Things to Know
There are a few things you need to know before you start an LLC. All of these items are necessary for creating your articles of organization, which you’ll submit to file your LLC.
1. Choose a Name for Your LLC
Choosing the LLC name is the first step in preparing to file. The business name has to be unique in your state, so you should do a preliminary name search in your state’s business name directory to check on name availability. You can also register any alternative business names or any abbreviation of your name as “doing business as” (dba). You can file to reserve a business name with the Secretary of State in your state to keep that name until you file your LLC. A name reservation usually lasts one to three months.
2. Know what type of income you will receive
When starting an LLC, it’s important to understand the different types of income and how they can affect your tax filing.
- Ordinary income — Also known as active income, this is the type of money you make from your general business activity.
- Passive income — This type of income comes from any business in which you’re not actively involved, such as real estate rental income, royalties, affiliate marketing, or being a partner in a business.
- Portfolio income — Any income from investments is considered portfolio income, and can include being a shareholder, savings account interest, and stocks.
3. Know what business address you will use for your LLC
Many business owners who transition from being a sole prop to an LLC work out of their homes. If you don’t have a physical location for your business, you’ll need to determine another address to use. You may want to use a PO box, virtual address, or your registered agent’s address (more on that below) to keep your personal information private.
4. Know the purpose of your business
The state in which you register your LLC will want to know what type of business you’re running. State law may require that you obtain business licenses for your work. This is important for tax purposes, too.
5. Know how your business will be managed
You’ll need to determine if your LLC will be manager-managed or member-managed as part of your LLC’s business structure. This determines who can sign contracts, enter into agreements, sell assets, use bank accounts, manage employees, and take out financing on the business’s behalf. In a member-managed LLC, members (such as the owner or partners) handle day-to-day operations and management of the business. In a manager-managed LLC, outside parties, including other LLCs, handle the operations of the business. These managers may or may not be members of the LLC.
6. Know what registered agent you will use and their address
A registered agent acts as your primary point of contact for any government correspondence regarding your LLC, including as your agent for service of process if you’re ever sued. They’ll file your paperwork on your behalf and will receive tax notifications and compliance information. You can act as your own registered agent if you have a physical address in the state where you’re filing your LLC, but your LLC can’t be your registered agent. It’s often a good idea to use a professional such as a certified public accountant or registered agent service as your registered agent, because they can navigate some of the finer points of the process. Also, you can use their address as your business address if you don’t have a physical location.
7. Know the duration of LLC after articles of organization
The length of time your LLC lasts after you’ve created articles of organization will vary by state. Most are limited to 20 years, but you can get a “perpetual” LLC in certain states if you don’t file a dissolution date.
Steps to Filing an LLC
Once you know the information above, you can start filing your LLC. A registered agent can handle this for you, but you should understand the process. Follow these steps to start an LLC and get your formation documents:
Submit Articles of Organization
Articles of organization or certificates of incorporation are the legal documents that establish your company as a business entity. You’ll file your articles of organization and pay a filing fee with the business filing agency Secretary of State in the state where you intend to do business, usually the Secretary of State or Department of Commerce. You’ll get a certificate of formation once filing is complete.
Apply for an EIN number
An employer identification number (EIN), also known as a Federal Tax Identification Number, is like a Social Security number for your business. It’s a nine-digit tax ID number that the Internal Revenue Service (IRS) uses to identify you for tax purposes. To apply for an EIN with the IRS, you’ll complete the necessary SS-4 form and submit it, either online, by fax, or by mail. Your registered agent can also handle this step for you.
Draft an operating agreement
The LLC operating agreement is a written document outlining how your LLC is managed. It’s not necessarily required by every state to file an LLC, but it’s a good idea to have one in place, especially if you have multiple partners. The LLC operating agreement will have five main parts:
- Ownership percentages
- Rights, responsibilities, and compensation
- Terms of joining or leaving
- Terms of dissolution
- Severability clause
Your LLC operating agreement is also where you’ll outline whether your business is member-managed or manager-managed, and whether or not it’s a general partnership or single-member LLC. (If you have multiple partners, you may consider a limited liability partnership or LLP.)
Prepare a banking resolution document
A banking resolution document defines who gets to control the LLC’s banking needs. You’ll need to determine which bank you’ll be using and get the signatures of all the LLC owners who will have rights to use the bank account.
Open a business banking account
Opening a business bank account is an important part of differentiating your LLC’s finances from your personal finances. There are many benefits of having a business bank account, particularly when it comes to tax time. You can choose from a number of business banking options depending on your business needs and banking preferences, like Nav Business Checking.
Keep your LLC in good standing
To keep your LLC in good standing, you’ll need to keep up with annual filing requirements with the state agency, including filing an annual report, usually on the state’s website. If you have shareholders, you’ll need to hold an annual meeting. You’ll also need to renew your business names, including DBAs. You’ll also need to calculate estimated taxes, including state taxes. This may be done on a quarterly basis. You can hire a professional service such as your registered agent to handle these requirements for you.
LLC tax forms to be aware of:
These tax forms are important for LLCs.
- Schedule C — for reporting income or loss.
- 1065 Form/K1 Form — for reporting partnership profits, losses, and deductions.
- Form SS-4 — the form to apply for an EIN.
- Form W 9 — provides your Taxpayer Identification Number (TIN) to anyone who needs to file information with the IRS, such as your accountant, contracted employer, or anyone who pays you income.
You can learn more about these forms at IRS.gov.
Nav’s Verdict: Starting an LLC
Starting an LLC can be a good way to establish your business’s credibility, limit your personal liability, and make your small business official in your state. It can also help you get small business loans and build your business credit (learn how to establish business credit). Whether you’re a sole proprietorship or an LLC, Nav can help you find options for small business financing and business credit cards — sign up for a free account to see your options.