llc formation: frequently asked questions about llc formation

Question: What exactly is created through llc formation?

When you step through the process of llc formation, you create an llc. The acronym "llc" stands for limited liability company. A limited liability company is a business entity that's legally separate from its owners or managers. Among other things, this legal separation means that if someone sues the LLC, the LLC's owners aren't by simple virtue of their ownership liable for the debts and obligations of the llc. In comparison, the owner of a sole proprietor and the owners (partners) in a partnership are responsible for the debts of the proprietorship or partnership.

A simple example can show you how powerful this "limiting" of the liability can be. Suppose two entrepreneurs, Jack and Jill, each operate a construction business. Jack operates as a sole proprietorship. Jill operates as an LLC. Further suppose that an angry customer sues both contractors. Maybe some project has gone horribly wrong. The customer suing Jack can look both to the proprietorship (the business) and the proprietor (Jack) for damages. The customer suing Jill can probably look only to the LLC (again, the business) and not the owner (Jill) for damages. In this case, Jill limits her economic losses to whatever assets the llc owns.

Question: Does llc formation work for all types of businesses?

You can conduct just about any business as an llc. The one thing you need to be aware of is that some professions can't be operated as llcs. When this is the case, states usually allow professionals in that state (doctors, lawyers, dentists, accountants and so on) to operate as professional limited liability companies, or pllcs.

Question: Does llc formation make sense for real estate?

Yes. And such an ownership/investment structure can make sense. A couple of potential problems exist with such a decision, however: First, you may get more practical asset protection through just buying additional liability insurance. Second, you may not really protect your most valuable assets if you put, say, all of your real estate investment property into the same llc. (What you might want to do is have separate llcs for each individual real estate investment.)

Question: What does llc formation cost?

LLCs increase your business and/or investment costs in two ways: First, the state or states in which you operate the LLC require both an initial setup fee and then an ongoing annual license or franchise fee. (You can think about these fees as the price you pay the state for limiting your business or investment liability.) Costs vary but typically run from less than a $100 to to several hundred dollars a a year.

A second cost associated with llcs is the extra financial management costs you'll. An llc's tax return may be more complicated and expensive to prepare, for example. And an LLC's bank account may cost more in monthly fees.

Question: Do you need an attorney's help for llc formation?

I get this question all the time and I'll give you my standard answer. If you're setting up an llc purely for tax reasons, of if you're used an attorney to set up an llc before, I think you can do the setup yourself using either free online resources, do-it-yourself guides like I provide here, or from one of the "set up own LLC" books.

If you're setting up an llc for asset protection reasons, I observe that entrepreneurs and investors often feel like they get excellent value from spending the extra money on a good attorney who not only steps you through the process but also explains the liability protection.

Question: Which is the best state for llc formation?

In most cases, the most practical state in which to form your llc is the state in which you're operate your business or the state in which your investment is located.

That said, some people pick other states and some of the time, going with another state's LLC can be a good decision. Attorneys, for example, often like Delaware llcs. Why? Delaware provides entrepreneurs and investors with something called a multiple series llc which lets you compartmentalize investments and business activities within a particular LLC into subsidiary LLCs. Many attorneys also point out that the Delaware courts are some of the most sophisticated and business friendly in the country.

Another popular choice is a Nevada llc formation. Nevada llcs as well as Nevada corporations are popular with some people because Nevada doesn't levy a state corporate income tax. In some circumstances, a business owner or investor might save state income taxes by choosing Nevada llc formation. (This idea is, in my opinion, way, way oversold, however.

Question: Can an llc own another llc?

In most cases, yes. But this is a tricky situation and one you may want to explore with a local attorney and CPA. In many situations, state law says who can and can't own an interest in a particular type of business. For example, states often have rather strict rules about who can and can't own interests profession-type businesses such as medicine, law, dentistry, public accounting, architecture, and so on. If you're operating one of these businesses as an llc or a pllc (a professional limited liability company), these same state laws may control how and when you can use an llc.

And here's something else to consider: Tax law sometimes has very strict requirements about what sort of taxpayer can and can't own a particular type of entity. (Mostly this has to do with S corporations.) For example, a single member llc can often own shares in an S corporation, but a multiple member probably can't. To further muddy the water, an S corporation usually can own an interest in both single member and multiple member llcs. Accordingly, if you think an llc might want to own another business or might be owned by another business, you probably want to get some help from a tax practitioner.

Question: Where can I locate a registered agent?

The state in which you set up your llc wants to know the name of a real state resident the state can contact if and when it needs to communicate with the llc. This "real state resident" is called a registered agent.

If you're setting up an llc in the state in which you reside, you can and probably should be your own registered agent. (Note, though, that who the registered agent is is public information,)

If you're setting up an llc in some other state, you'll need to pay someone in that other state to be your registed agent. Often this costs you a few hundred dollars a year in additional fees. You can probably find a registered agent by doing an Internet search. If you use an accountant or attorney in that other state, that person or firm will probably also happily and easily act as your registered agent.