A sole proprietorship is the simplest and most common type of business, but it's also the riskiest. Every day that you run your business, your personal assets are on the line.
As your business acquires employees, property, and assets of its own, it makes sense to separate your personal life from your business life. Forming an entity such as a limited liability company, or LLC, shields your personal assets from business debts and liabilities.
Let's take a look at the business documents required to set up an LLC.
Overview: What's an LLC?
An LLC is a legal business entity formed by one or more owners, known as members. Unlike a sole proprietorship, an LLC has rights, responsibilities, debts, and assets separate from those of its owners.
An LLC is a relatively simple business structure, with profits from the business passing through to the members' personal income based on their share of ownership. Any number of members may elect to create an LLC, and members may be added or removed as the business grows.
Benefits of forming an LLC
There are three major advantages of forming your business as an LLC.
1. Limited liability
A primary motivation for forming an LLC is to shield yourself from legal and financial liability for your business. As a sole proprietor, your personal assets may be seized to satisfy business debts or legal judgments. Forming an LLC protects your personal property and income from those risks.
2. Pass-through income
The profits from an LLC are passed through to the owners' personal income for tax purposes, just as they are with a sole proprietorship or partnership. This is simpler to manage and generally results in lower taxes than corporations.
LLCs may elect to be taxed as S corporations instead, giving owners tremendous flexibility in managing their tax burdens.
3. Active ownership
An LLC may be managed solely by its members or by anyone appointed to serve as manager. This gives you the flexibility to retain control and actively manage the business in whatever way you'd like.
The 7 documents you need to create an LLC
The following summarizes the documentation requirements for creating an LLC. Depending on the nature and location of your business, you may be able to skip one or more steps.
1. Internal Revenue Service (IRS) Form SS-4
If you don't already have one, you'll need to obtain an Employer Identification Number (EIN) for your business via IRS Form SS-4. You can download the form to file by mail, or simply and receive your EIN immediately.
Your EIN is used on tax forms and other official documents to identify your business.
2. Name reservation application
Before filing any LLC formation documents, you will need to choose a name for your LLC and run an availability search to determine if it's already taken. You can usually run a name availability search on the website of the secretary of state or corporations bureau.
Generally, states have specific rules for ensuring that a business name differs enough from those of existing businesses to qualify.
For example, Utah specifies that using a plural form of a word is not enough to distinguish one business name from another. If the name "Mad Rebel" is taken, you cannot choose "Mad Rebels."
Besides availability, you must check whether your name is permissible. Each state has unique naming rules including prohibited and restricted words.
In Utah, for example, you cannot use the word "Thrift" in a business name without requesting permission from the Department of Financial Institutions. Each state also has specifications for including corporate designators such as LLC in your business name.
Once you have a viable name, you may file a name reservation form with your state (though it’s not required) to hold it while you file your LLC paperwork.
You can usually find all of these materials on the secretary of state website.
3. Articles of organization
To form your LLC, you must submit to the state articles of organization, also called a certificate of organization (or certificate of formation in some states). You can generally download the appropriate form from the secretary of state website.
When filing your form, make sure to include the correct number of copies. Often, you're required or permitted to submit two copies, one for the state to keep and one to stamp and return for your records. Failing to include the prescribed copies is a common cause of rejected filings.
Each state has its own requirements, but articles of organization generally include the following:
- Business name: Be sure to write your full, legal business name exactly as it must appear according to your state's rules.
- Business purpose: Some states require a specific purpose, while others allow you to state broadly that your business will engage in lawful business activities. For example, in Illinois, professional LLCs must state the specific professional services they will engage in.
- Duration: Some states ask you to specify whether your LLC has a dissolution date. A few states set a statutory limit on the duration of an LLC, but in most cases, you may designate your agreement as perpetual.
- Primary business address: This is the physical location that serves as the base or headquarters of your business operations.
- Ownership: Your agreement must list all members of your company with full contact information. You will also need to indicate what share of the business each member owns.
- Management: Your agreement must specify whether your LLC is managed by its members or by designated managers. Names and full contact information for all managers must be provided.
- Registered agent: Your business must appoint a registered agent who is available during regular business hours to accept delivery of notices of lawsuits, known as service of process, and other official documents. There are companies that provide professional registered agent services for a fee.
4. Operating agreement
An operating agreement, also known as a company agreement, establishes the ground rules for running your LLC and the rights and responsibilities of its members. It also confirms how profits and losses will be distributed among them. Usually, members receive profits as income based on their share of ownership.
Operating agreements are not usually required by states as part of the formation process, but they are essential for establishing how your LLC will be governed. All members must sign the document to validate the agreement.
If you want to write your own operating agreement, you can find samples online, but since this is the legal foundation of your business, it makes sense to get input from legal counsel before signing. Generally, operating agreements include the following:
- Business name and address
- Registered agent address
- Formation date and duration
- Member names, roles, and contact information
- Contributions and shares of ownership
- Distribution of profits and losses and compensation plans
- Manager names and contact information
- Meeting schedules and voting rights of members
- The process for adding or removing members
5. Initial and annual reports
States need to have accurate, up-to-date records on businesses operating within their borders. To maintain them, most states require LLCs to file periodic reports to confirm basic information about their operations.
States use a wide range of names for these reports, including annual reports, statements of information, franchise tax reports, business entity reports, and annual certificates.
They are often due annually or biennially following the year of formation, but in some cases, they're due less frequently. Pennsylvania, for example, collects them every ten years.
A few states, including Alaska, California, Nevada, and Washington, require LLCs to file an initial report or statement of information at the time of LLC registration.
6. Tax registrations
In many states, your LLC will need to register with the department of revenue for one or more tax types. These may include general business entity taxes, employer taxes, and sales and use taxes.
Usually, tax registration requirements and forms are included with business formation resources in the state's business portal.
7. Business licenses
Depending on the nature and location of your business, you may need one or more business licenses. Typical licenses for small businesses include the following:
- Home occupancy permits
- Premises permits for features such as signs, alarm systems, and elevators
- Licenses for regulated activities such as food preparation and daycare
- Professional licenses for services such as engineering and architecture
In most cases, you can apply for licenses online through the state corporations division.
With all of these documents, it pays to be meticulous. Missing a detail can result in rejected paperwork, sending you back to start over and delaying your approval. Getting sound legal and financial advice as you form your business is a wise investment.
Set your business up for success
Forming an LLC is a major milestone in your company's growth. It marks the beginning of your business as a separate entity from yourself, with assets, liabilities, and responsibilities of its own.
Make it official the right way, with careful paperwork and a plan for future filings that meets all of your state's documentation requirements.