Forming a Limited Liability Company: The Pros and Cons in California

Forming A Limited Liability Company: The Pros And Cons In California

A limited liability company (LLC) is one of the options for individuals who wish to start a business. It combines the tax advantages and flexibility of partnerships and the liability protection that comes with a corporation. There are no limitations in the number of members for an LLC. One person or many members can be the owners. There are a lot of things you should know before forming an LLC in California.

Starting an LLC in California

If you have already decided, you should be aware of the steps needed to start your business. Familiarize yourself with the process to avoid complications.

1. Check the Code of Regulations of the state to understand the naming rules before starting. Make sure no other business has taken the name you chose. Verify this through the state’s website.

2. California requires LLCs to designate an Agent of Service of Process to serve as the point of contact of your LLC with the state. This representative will also send or receive legal papers on your LLC’s behalf.

3. File the Articles of Organization. State if it will be a member-managed or manager-managed LLC.

4. Another requirement in California is the filing of the Initial Statement of Information with the Secretary of State. Do it online, by mail, or in-person within 90 days of the formation of your LLC.

5. Prepare an operating agreement that outlines the structure of ownership and the operating procedures of your LLC.

6. Get an Employer Identification Number (EIN). It helps the IRS identify the business for tax and filing purposes. You will also need it to open a separate bank account for your LLC, hire employees, and apply for certain permits.  

7. Sign all legal documents properly. After forming an LLC in California, you can also take extra steps to protect your business. You can open a business bank account, get a company credit card, or buy insurance. Your responsibilities do not end after you start the business. Always keep the following in mind:

·       Understand California taxes.

·       Report income to IRS.

·       Submit biennial reports to the Secretary of State.

·       Pay for annual franchise tax.

Choosing to have an LLC structure has pros and cons. So, it is crucial to understand all possibilities and weigh all the options before making up your mind.

The Pros of Starting an LLC

  • One of the advantages of an LLC is the limited liability it offers. Members do not have to worry about their personal assets as they are not liable for the actions of the company. So, make sure there is a clear distinction between the business’ finances and the members’ assets.
  • LLCs are usually pass-through entities. All profits and losses go to members without government taxes on a company level. Members can file all of these on their Federal Income Tax returns. Because of this, you may find it easier to file taxes. 
  •  The owners can choose how to manage the business. They can share the decision-making responsibility amongst themselves and be a member-managed LLC. California also allows manager-managed LLCs, which means you can hire/appoint a manager or managers that are more experienced and knowledgeable.
  • You do not have to spend a lot of money on fees and initial paperwork. You may also find the process easier compared to the one needed when forming a corporation. In California, you have to pay for a one-time filing fee worth $70 to the Secretary of State. Submit the payment with the Articles of Organization.

The Cons of Being an LLC

  • There are limitations to limited liability. LLCs do not protect you from risks and vulnerabilities completely. In some cases, a judge can rule that the LLC does not protect your assets. This situation happens when there is a failure to keep business transactions and personal finances separate. Another possible reason is the fraudulent management of a business resulting in other people’s losses.
  •  When it comes to taxes, the IRS sees LLCs the same as they do with partnerships. The IRS does not recognize LLC as a tax structure the same way they do with corporations. So, the government treats members as self-employed individuals. Members should pay for their social security and medicare taxes, which are collectively called self-employment tax. The total net earnings of the business will be the basis for the tax.

    If the members decide to have S corporation tax status, they need to file the required paperwork with the IRS. Members who work for the company will have to pay social security and medicare taxes based on the actual compensation and not the pretax profit of the company.

Forming an LLC in California is a good option for startups. But, understanding the pros and cons will help you make the best decision for your business.