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Business 101: Entity Formation – LLC

Welcome back to another fun filled addition of our Business 101 – Entity Formation Series. Our last blog, which focused on C Corps, was the first installment of our series on limited liability entities. As you will recall the owners of a C Corp, known as shareholders, hold freely transferable ownership interests in an organization with a centralized management structure and limited liability. This week we will focus on the Limited Liability Company or LLC, a slightly more user friendly entity selection.

It is no secret that LLCs are the fastest growing business entity selection in the United States and that is for a good reason; They are a hybrid entity, meaning they offer the limited liability status of the heavily regulated and doubly taxed C Corp, all while maintaining a degree of informality and flexibility of pass through entities like the Sole Proprietorship or General Partnership.

There are some other very interesting things that make LLCs a “hybrid entity.” First, LLCs are flexible in who can be members (owners of LLCs) – LLCs can have corporate ownership, unlike S Corps. Second, LLCs can have one owner (like a sole proprietorship) or many owners (like a C Corp).  Third, members are allowed to allocate profits and losses in a proportion that is different from the members’ relative capital contributions, and the IRS actually allows this for tax purposes. Fourth, LLCs can even add non-voting members to the organization whose rights to receive profit without control are similar to those with preferred stock in a C Corp.

The other more traditional defining characteristics of an LLC include limited liability, pass through taxation status and flexibility in management structure.

Limited Liability: Unlike general partners or sole proprietors, members of an LLC are only liable for the debts of the organization up to the amount they contributed. This is a huge benefit as the personal assets of members cannot be reached by the LLC’s creditors. (Some exceptions in certain cases of misfeasance and malfeasance.) Tax Flexibility: Unlike a Partnership, Sole proprietorship or C Corp members of the LLC get to determine how they want to be taxed. Members of an LLC will outline in their operating agreement how the LLC will be treated for tax purposes. If an LLC is owned by a single member they may elect to be taxed like a sole proprietorship i.e. on the member’s personal federal tax return. LLC’s can also elect to be treated like a traditional partnership for tax purposes. Members of an LLC can even choose to file as if they were a corporation. Management Structure Flexibility: LLCs are able to decide at the point of filing their Articles of Organization whether they wish to be manager-managed or member-managed. Almost all LLC statues provide that an LLC is to be managed by its members, but the operating agreement can augment this.

How would you go about forming an LLC in Massachusetts? Well, there are 6 essential steps you should take:

  1. Call on Lake Shore Legal at 508-943-7800 to be sure that this entity selection is right for your venture.

  2. Check the Secretary of Commonwealth’s website to select an available and appropriate legal name. 

  3. Draft and file your Articles of Organization with the Secretary of Commonwealth. 

  4. Draft your Operating Agreement. Be sure to include how your business will be ran (managers or members), the capital contributions, and how profits will be allocated.

  5. Apply online at the IRS website to obtain an Employer Identification Number (EIN).

  6. Register with your local municipality and apply for any business license and other certificates required by your profession.

As you can see from this bLAWg, forming an LLC to operate your next venture is fairly straight forward and offers a great many benefits. However, I do advise clients to be cautious and consult an attorney to aide in the drafting of a Operating Agreement when establishing a LLC with multiple members. Having an attorney aide in creating your Operating Agreement can save you from major headaches down the road whether with the IRS, State Government or even other  members.

Please call Lake Shore Legal, LLC. at 508-943-7800 if you have any questions about getting your next venture off the ground.

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