LLC Basics - A Small Business Guide

Are your personal savings protected? If you operate a business without a formal structure, every transaction puts your home and other assets at risk. This is one of the many reasons why there are millions of Limited Liability Companies (LLC’s) in the US. An LLC is your essential legal shield, granting personal protection and unmatched tax flexibility. Let's break down the benefits and the critical steps needed to maximize them.

LLC’s at a Glance

Category	Key Benefit	Client’s Action Item	Sonata's Role
Liability	Personal assets are protected from business risk.	Keep business finances separate (Essential for "Legal Shield").	Set up clean books and recommend banking structures.
Flexibility	Choose one or multiple owners and management styles.	Form an Operating Agreement (imperative with multiple owners).	Advise on ownership percentages and capital usage.
Taxation	Flexible entity that can reduce self-employment tax via S-Corp election.	Consult a tax professional for the optimal election (S-Corp, C-Corp, DE).	Analyze and implement the most tax-efficient entity structure.

What are LLC’s?

Limited liability companies are a separate legal entity that can be utilized for various purposes such as operating a business and holding assets. It is commonly thought of as a “legal shield” between the owner and the business’s assets and liabilities. If the business goes under or another party sues on business grounds, the most that can be taken is what is encapsulated in the LLC. Generally speaking, other parties can’t reach beyond the LLC to the owner’s assets.

For example, let’s say you own rental property. The tenants decide to sue you on contractual grounds. Without an LLC, these opposing parties can seize your personal savings and your home. With an LLC, the farthest they can reach is the rental property. An LLC is a flexible entity structure. There can be one or numerous owners. The owners can be individuals or other entity types (such as other LLC’s, C-Corps, S-Corps, estates, non-for-profits, etc.). There is also flexibility in how the LLC is managed. All these factors, along with the ease of creation, are what make LLC’s so favored in today’s business environment.

How to form an LLC

LLC’s are formed under state statutes and are simple to apply for. Prospective LLC members will need to visit their state’s website and file an application. For the Hoosiers looking to form an Indiana LLC, use this link to register with the state: https://inbiz.in.gov/start-business

After a successful registration, you can then apply for a Federal Employer Identification Number (EIN). This is often required for a business bank account and is also utilized for filing the applicable tax return.

How to create an LLC:

1. Identify the state to register in

2. Choose a name (tag “LLC” or an equivalent at the end of it!)

3. Designate a registered agent who will be administratively responsible for the LLC

4. Craft an operating agreement and decide the management structure

5. File with the state

6. Apply for an Federal Employer Identification Number (EIN)

LLC’s and Taxes

LLC’s are referred to as passthrough entities. Meaning they often don’t pay taxes themselves. Instead, they pass any income, loss and credit items to its owners, and then those owners report the share of activity on their returns. LLC’s have different filing requirements by default depending on how many owners there are. If the LLC is owned by just one individual, then all income and loss items are reported on Schedule C of that person’s 1040. If there are multiple owners, LLC’s are defaulted to being taxed as a partnership. In this case, Form 1065 is prepared and each owner will receive a Schedule K-1. Each owner then puts the items from the Schedule K-1’s on their individual return. Additionally, LLC’s can make elections to be taxed as other entity types. A few of the options are S-Corps, C-Corps, and disregarded entities. I recommend getting with a tax advisor like myself for these elections as they can be costly and complicated to unwind. At Sonata, I understand your goals, business organization and compensation structure to ensure you are tax efficient before you file.

Best Practices

If there are multiple LLC owners, it is imperative that a thorough operating agreement be made. This can include an outline of the business purpose, how the business will be managed, ownership percentages, how capital is used, etc. This encourages all parties to have similar and clear expectations of the road ahead and can curb frivolous disagreements when they inevitably arrive. Forming an LLC is just the beginning of your business’s financial and accounting framework. The highest benefit comes from choosing the best entity structure for your situation. Let’s ensure you are on the right track.

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