For the self-employed, a Limited Liability Company, or LLC, is a great way to structure your business. An LLC is a business form that combines the best of a corporation (limited personal liability) with the best of less structured business forms like partnerships and sole proprietorships (simplicity.)
Similar to partnerships, LLCs are flow-through entities (FTEs), also known as “pass-through” or “transparent” businesses. FTEs allow revenue generated by the business to “flow through” to the owners; in other words, although individuals are legally protected from financial liabilities associated with the business, they draw their income directly from sales revenue or contract-based fees.
Although an LLC is a separate legal entity, it is not a separate taxable entity, and you will need to report profits and losses on your personal income taxes, but the great news is that the liability protection of an LLC designation ensures that you cannot be held responsible for business debts and claims.
Since the early ’90s, the popularity of LLCs has grown tremendously, due in no small part to the booming freelance economy.
Understanding the Corporate Veil
If you are planning to form an LLC, there is one phrase you will hear again and again: the so-called “corporate veil.” The corporate veil—really, it’s more like a shield—is what protects your personal assets from financial liabilities associated with your business.
Unfortunately, over the last 20 or so years, many individuals have formed LLCs to protect their semi-legitimate and illegitimate business activities. Courts have taken notice, and now attorneys are beginning to “lift the veil” by challenging business entities that are registered as LLCs, but function as direct extensions of the business owner’s personal affairs.
In general, attorneys and courts are able to lift the veil only when an LLC has failed to comply with generally accepted standards for record keeping. Forming an LLC is simple and relatively inexpensive—the whole process, from application to acceptance, will cost you only a few hundred dollars—but that doesn’t mean you can rush through the process.
To establish your business as an LLC, there are a handful of documents you must prepare correctly; if you fail to comply with state and federal regulations, you run the risk of exposing your assets, and ruining your reputation. So before you print up business cards, make sure you have your paperwork in order.
Two Essential Documents
1. Articles of Organization
Regardless of the structure of your business, you will need to file articles of organization (also known as a “certificate of organization” or “certificate of formation”) with your state government, typically through the Secretary of State’s office. This document identifies your business: you provide the state with your official operating name, your business’s fixed address, and the contact information for all member-owners.
Many states have a simple one or two-page form that will help you prepare acceptable articles of organization, but you still might find it useful and beneficial to work with an attorney, just to make sure that your charter will be iron-clad in the eyes of the courts.
2. Operating Agreement
Although most states do not require an operating agreement, this document will go a long way towards helping you establish and maintain the corporate veil. Your operating agreement is essentially a business plan, it explains your business structure, your decision making process, the roles and responsibilities assigned to members, and how the business will be liquidated in the event that you decide to close your doors.
Additionally, you should consider compiling the following documents (in nearly every case these documents are not required by the state or federal government, but, as always, it’s better to be safe than sorry):
- Tax returns from all levels of government.
- Copies of all financial statements for the past five years, including up-to-date credit reports for each member-owner
- Copies of any written agreements between members
When you are self-employed, you need to both look and act professional. Forming an LLC accomplishes both of those goals.
By Marshall Lee