Forming an LLC: 5 vital steps

Headshot for Amanda Graber, Content Marketing Specialist for ComplYant, a business tax tool for entrepreneurs and small businesses.
By Mandy Graber

Going into business for yourself is the dream of many entrepreneurs. Maybe you’re among them. Whether you’re looking to open a boutique to showcase your latest fashion designs, find the perfect mix of flavor and herbs in your own tea shop, or create custom work as a carpenter, you’re not alone in the small business world.

More and more entrepreneurs are investing in themselves and opening their own companies. In fact, in 2021, the number of new businesses skyrocketed over previous years with a sudden 53% increase in applications. Since then, growth has continued to be steady, remaining well above pre-2021 levels. 

When setting up your business, the structure you choose can significantly impact its foundation. Many business owners start as sole proprietors, or some may go into business with a partner. Others use a state-recognized entity known as a limited liability company or LLC. 

An LLC can offer entrepreneurs the best of both worlds: liability protection and pass-through taxation. If you’ve determined that an LLC is the right choice for you and your business, then there are some important steps you need to take to give your new business the best chance at success.

#1 - Determine if you have a hobby, side hustle, or an actual business

It may seem like a simple question, but there are some differences between these three scenarios. There are potential tax advantages, like specific deductions for each of these, even hobbies in some cases. 

However, the IRS does have some criteria you’ll have to consider to be sure you’re filing your income correctly. After all, money earned from your food truck business isn’t necessarily taxed like the extra cash you earn from creating custom needlepoint. Some of the factors that can affect how your income is classified might include these:

  • Your intention, from the beginning, is to make the endeavor profitable
  • You depend upon the income from this activity for your livelihood
  • You maintain business standards, including complete and accurate accounting and other records
  • You expect to make a profit in the future from the assets of your endeavor, despite any initial losses in the startup phase

#2 - Confirm an LLC is best for your business

The way you structure your business can affect many factors, from the tax rates you’ll be asked to pay to the regulations you’ll have to follow. Some of the most frequently used structures are sole proprietorships, partnerships, C corporations, and S corporations. LLCs are also very popular for the advantages they offer.

What to know about the LLC business structure

As a structure, an LLC is only recognized at the state level. This means that when you file at the federal level, the IRS doesn’t have a specific LLC designation. However, the IRS does have some general rules

  • If an LLC has a single member, the IRS will treat it as a “disregarded entity,” and the LLCs taxes are filed as part of the owner’s return.
  • If an LLC has two or more members, the IRs will classify it as a partnership for federal tax purposes.
  • In some instances, LLC owners can file Form 8832 and elect to be treated as a corporation by the IRS.  

#3 - File the necessary paperwork

Opening a business can require a lot of paperwork. Some business structures require less formal filing than others, and the number of permits and licenses you’ll need can also vary depending on your company’s industry. The are some common documents and applications that are typical for many LLCs:

Employer identification number

Often, business owners decide to apply for an employer identification number from the IRS. While an employer identification number (EIN) isn’t always required for an LLC, having one can be a good idea. After all, it can make filing taxes easier and boost your credibility with vendors and creditors. Most importantly, as the name suggests, you must apply for an EIN if you ever have employees. 

LLC operating agreement 

Some states require LLCs to file an operating agreement. However, even if your state doesn’t require this document, having one may be a good idea. An operating agreement can protect you and your business. It outlines the financial and functional decisions that will direct your company's internal operations. 

Once all of the members have signed it, it can become a binding contract that protects the company’s liability status and the agreement in the eyes of the state. A standard agreement should include the following:

  • Percentages of ownership
  • Buy-out and buy-in rules
  • Voting rights
  • Powers and responsibilities of owners
  • Distribution of profits and losses

Business registration

It’s essential to register your LLC in the state where you do business or founded your company. Typically, you’ll do this online or by mail with the Secretary of State’s office, the state’s Business Bureau, or the state’s Business Agency.

Some states also require you to register even if you simply do business within the jurisdiction of the state. You might be considered to be doing business in a state if any of the following apply:

  • Your company has a brick-and-mortar location there
  • You hold in-person meetings with clients or attend trade shows in the state
  • You have customers in the state who generate a significant amount of revenue
  • You have employees who live or work in that state

If you have questions, contact the corresponding organization in each state where you do business for more information. 

Business permits and licenses

Business licenses and permits may also be required for your business. Depending on the jurisdiction, you might have to carry a license on the state or local level that allows you to do business in the area. 

In other cases, you might be required to hold a special license or permit due to the industry of your business. The industries that require these are often subject to additional oversight: 

  • Child care
  • Health and safety services
  • Alcohol sales
  • Food handling
  • Professional services (accounting, legal consulting, etc.)

The application process for these licenses and permits can vary by jurisdiction. Check the requirements of your area and be sure to apply by any set deadline. If possible, apply online. Allow extra time for mail-in applications.

Business plan

Finally, it’s a good idea to write a business plan for your new endeavor. Thinking through how you’ll shape your business can go a long way toward setting your new company up for success. Be sure your business plan includes some important features:

  • A company description
  • Market analysis
  • Products and services
  • Financial analysis and projections

A good business plan can help you make solid decisions about the future of your company. It can also help you secure potential financing and provide direction if you need to find your business’s true north again. It’s worth the time to learn how to write a business plan.

#4 - Get funding and insurance 

When your business is formally recognized with all the right paperwork, it’s easier to approach financial institutions and investors for funding. Fortunately, business owners have many funding options potentially available:

  • Investors
  • Grants
  • Loans
  • Business credit
  • Equity

The options don’t end here. Some owners use crowdfunding or weigh their options between owner loans and owner investments. In the end, however, most business owners find that having documentation like an EIN, proper registration, and even a solid business plan can help to secure needed money.

Additionally, business insurance can be essential, especially for specific industries. Not only does investing in insurance help to protect your business from certain liabilities and help shield your investment from loss, but it may even qualify you for additional tax deductions.

#5 - Be ready for taxes

With the right preparation and understanding of the process, filing taxes for an LLC can be relatively straightforward. Here are the basic steps:

Gather necessary documents

These include financial statements, income and expense reports, and any other documents the IRS may require. 

Choose the correct filing status

An LLC is recognized at the state level but not by the IRS. You should file based on how the IRS will treat your company based on your circumstances. 

File your tax return

You can do this online or by mailing in your paper form.

Tips for filing LLC taxes for the first time

  • Set Up a Record-Keeping System: A record-keeping system ensures your taxes are accurate and filed before the deadline. Keep track of all income, expenses, and other business transactions in an organized manner, and save all relevant documents in a safe place. 
  • Seek Professional Help: If you’re new to filing taxes, it’s a good idea to seek the help of a qualified tax professional. A professional can help you understand the tax requirements of your business and can ensure that your taxes are filed accurately and on time. 
  • Take Advantage of Tax Breaks: As a business owner, there are certain tax credits and deductions you may be eligible for. Research any available tax breaks and make sure to take advantage of them. Doing so can help you save money and reduce your overall tax burden. 
  • Pay Your Taxes on Time: Making estimated payments and filing taxes on time is essential to avoiding penalties and interest fees. Consider a free ComplYant account that will find and track the relevant tax dates for your business.

Bonus step: Don’t miss a tax deadline 

Once you’ve formed your business, your work has only begun. As your LLC grows, you’ll have new challenges and opportunities. Maybe you’ll hire an employee. Or you might open a nonprofit to give back to your community using your company’s proceeds. 

A final tip? As your company grows, set yourself up with good bookkeeping practices. Accurate records of your cash flow, expenses, tax payments, and other receipts can prove a deduction or support a claimed business tax credit.

Taxes are inevitable, but being prepared can make them less daunting. Consider using tools like ComplYant so you never miss a business tax deadline.

Headshot for Amanda Graber, Content Marketing Specialist for ComplYant, a business tax tool for entrepreneurs and small businesses.
By Mandy Graber
Mandy is a seasoned content creator with experience in a wide variety of industries. She works alongside our ComplYant Tax Experts to help make tax-related content more accessible to everyone. In her long tenure as a writer and content creator, she has covered a wide array of topics, including insurance, education, financial technology, and more.

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