Do I Need an LLC?

Whether you’re just starting a business or already established, you will eventually need to decide whether to become an LLC (limited liability company) or remain a sole proprietor. Below are some situations when you should create an LLC and a few instances when it’s better to avoid this type of business structure.

You Need Personal Liability Protection

Unlike a sole proprietorship, an LLC is considered a legal business entity separate from its owners. This means, among other things, that any business losses are limited to the assets held under the LLC.

One of the main reasons for registering a business as an LLC is to protect your personal assets in the case of a lawsuit or to settle business debts.

There is some debate about how soon LLC owners can benefit from legal protection. The answer is different for everybody, but two suggestions are:

  • When you start earning consistent income: Some experts suggest forming an LLC after $100,000 in annual revenue. However, there’s a growing consensus that you should do so as soon as you start a business and have income streams or valuable assets eligible for legal protection.
  • Have risk of liability: Some industries and professions are inherently riskier. An LLC provides peace of mind before you accept your first paid assignment or hire an employee. You can register an LLC almost immediately if it helps you sleep easier at night.

Aside from business loans and credit cards for which you’ve provided a personal guarantee, LLC asset protection means you’re less likely to liquidate your personal assets in a legal dispute.

Sole proprietors don’t have this legal protection, and their personal assets are fair game after exhausting any business assets.

Be sure you keep all business and personal assets in separate financial accounts to avoid “piercing the corporate veil.” In short, business bank accounts used for personal transactions won’t qualify for personal liability protection.

You can protect yourself by using a business checking account to receive payments and pay expenses. This practice simplifies bookkeeping and business tax prep. While it’s an extra step, you can quickly transfer funds to a personal banking account when paying yourself.

Related: How to Pay Yourself As a Business Owner

You Want an Operating Structure

An LLC operating agreement is valuable to multi-member LLCs. It formally defines each co-owner or business partner’s role, responsibilities, and profit-sharing rules in case legal disputes arise. It can also be helpful when hiring employees. 

Not every state requires an operating agreement, but you can draft one for good measure. LLC formation services such as Northwest Registered Agent or LegalZoom can create tailored agreements and make future amendments. 

As an organized LLC, you can also list a business address. You can most likely use the address of your formation service or registered agent to avoid using your personal address on public documents, which can compromise owners’ privacy.

Tax Treatment Flexibility

By default, LLC income is passed through to the business owners, who must report it on their individual tax returns. However, if the business has employees, the LLC is responsible for the employer-side payroll taxes. 

If you think it might be beneficial from a taxation standpoint to register as an LLC, consult an accountant or other tax professional to run the numbers before you proceed.

You Need a Business Loan

It can be easier to qualify for a business or credit card as an LLC than as a sole proprietor. Lenders prefer working with LLCs and corporations because they are easier to assess a business’s activities and anticipated revenue.

LLCs can also build a business credit score, as many require an EIN (employer identification number). To be fair, sole proprietors can also apply for an EIN, start building business credit, and avoid using their Social Security number on sensitive documents. 

Being a formal business is helpful when applying for SBA loans from the Small Business Administration. SBA-approved lenders can provide more favorable interest rates and repayment terms than non-bank lenders’ short-term financing options. 

How to Form an LLC

You can apply for an LLC by following the procedures of your state secretary. For many, it’s worth the convenience and low cost of using an LLC formation service to help you save time drafting the necessary documents to remain legally compliant.

Related: How Much Does it Cost to Form an LLC?

Here are two LLC formation companies to consider:

Northwest Registered Agent

Northwest Registered Agent provides LLC formation at $39 per state (plus state filing fees) and 12 months of complimentary registered agent service. You can use a Northwest-provided business address that protects your privacy and provides limited free mail forwarding.  

You can also choose a free filing service that helps guide you through the necessary documents, although you must complete those yourself. Northwest Registered Agent can also help you build a business website and fill out additional business document templates to create your brand identity.

Get Started With Northwest Registered Agent

LegalZoom

LegalZoom provides one free filing package and two paid options, $249 (Pro) or $299 (Premium) plus state filing fees. The Pro package includes an operating agreement, over 150 business templates, an EIN, and an initial phone consultation to discuss business insurance and taxes. 

The Premium plan is ideal when you’re seeking hands-on help from a business attorney. You get unlimited 30-minute consultations on new business topics and unlimited changes to your LLC formation documents during the initial 30 days. 

LegalZoom can also be your registered agent, and they provide various personal or business services, including on-demand access to attorneys.

Get Started With LegalZoom

When You Don’t Need an LLC

There are several situations when an LLC might not be worth the hassle. Remember, you can always file later as your business expands and requires legal protection or financial benefits.

You Have a Low-Risk Business

If you’re an online freelancer, like a writer or a graphic designer, it’s possible to remain a sole proprietor for your entire career without much risk as long as your level of responsibility is relatively low. If the work you do won’t jeopardize the company’s finances or an individual’s safety, then you are likely fine.  In this case, the legal benefits may not be worth the effort of getting an LLC.

That said, it’s still a good idea to carry business insurance which can protect your personal finances if a customer gets hurt or sues for inferior results.   

You’re Just Testing Business Ideas

Forming an LLC won’t make sense if you’re just starting out and unsure if your business idea has growth potential. As long as it’s a low-risk business, you should be safe operating as a sole proprietor or general partnership. 

Even if you don’t apply for an LLC, it’s important to separate your business and personal finances by opening a business bank account. These accounts are often free and contain tools that make it easier to send invoices and estimate your taxes.   

Related: 7 Best Bank Accounts for Freelancers and Side Hustlers

You Are a Solopreneur

There is less incentive to become an LLC when you don’t have any co-owners, business partners, or employees. Additionally, you won’t benefit from a registered agent, and if you want to use an off-site business address, you can easily rent a virtual mailbox.

Additionally, you can hire independent contractors through freelance platforms or other channels for one-off projects as you need expert help and write off the business expenses.

Our ultimate freelancer guide provides several tips and tricks from successful entrepreneurs to help expand your online or local business. 

Summary

Forming an LLC is worth it for the legal protection, operating structure, or potential banking and tax advantages. However, it may not be worth the hassle if you operate a low-risk business or work on your own.

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About Josh Patoka

After graduating in $50k with student loans in May 2008 from Virginia Military Institute with a B.A. International Studies and Political Science with a minor in Spanish (he studied abroad in Sevilla, Spain for 3 months), Josh decided to sell his soul for seven years by working in the transportation industry to get out of debt ASAP and focus on doing something else with a better work-life balance.

He is a father of three and has been writing about (almost) everything personal finance since 2015. You can also find him at his own blog Money Buffalo where he shares his personal experience of becoming debt-free (twice) and taking a 50%+ pay cut when he changed careers.

Today, Josh relishes the flexibility of being self-employed and debt-free and encourages others to pursue their dreams. Josh enjoys spending his free time reading books and spending time with his wife and three children.

Opinions expressed here are the author's alone, not those of any bank or financial institution. This content has not been reviewed, approved or otherwise endorsed by any of these entities.

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mi b
15 days ago

S-Corp (or C-corp if you plan to do a 1202 transaction). Possibly an LLC if you are going to have disproportionate distributions or holding real estate. Just my $.02

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