Understanding Limited Liability Companies: A Guide to LLC Formation

[00:00:00]hey this is attorney Elizabeth potts-weinstein and today we're going to be talking about what is an LLC and how do llc's work so an LLC is a limited liability company this is a legal entity that you can form for a business or for any other kind of investment project like buying real estate things like that now a limited liability company is something that is set up that is separate from you personally it is taking your business or your investment project or whatever it is and putting it inside a little bubble that is separate from you now llc's limited liability companies are new and I put quote marks around that because they're not actually new they've been around for many many decades but they're new in the sense of the legal profession which thinks in terms of hundreds of years and they're also not something that's in every country limited liability companies are something that's in the United States most countries don't have something like that they might have some other kind of limited business and they usually have corporations maybe always have corporations that are kind of the old-fashioned way of setting up a legal entity for a business that's been around for hundreds of years the reason we have llc's is because corporations have a lot of formalities that are not appropriate for many situations it makes sense to have a corporation if you have a big giant business and you're pitching venture capital and it's going to go public someday and you have you know thousands of shareholders that own this business that Corporation is the right choice but what about when you have have a business that's just one or two or three people yes you can still set up a corporation but that's a whole lot of formalities that you're required to do that's fairly odd when you just have one or two or three people so a lot of times people would just have a partnership which is the default legal entity it's not even really an entity it's a it's a structure when you have more than one person going to business together now the problem with a general partnership an old-fashioned partnership is that each partner is personally liable for the stuff in the business including what the other partner does that you may not even have agreed to or know about that's very dangerous kind of business structure and I like literally never recommend that for any situation now if you're one person setting up a business the default is a sole proprietorship which is you and the business are the same that's not a terrible idea because theoretically you can control yourself and not do terrible things that you'll be liable for but it still has a lot of risk so the reason that llc's weren't created was to combine the great parts of having a corporation which is limited liability with the great Parts about having a partnership which is a lot of flexibility and informality so they smash that stuff together and made an LLC so as I said an LLC is like a corporation in that you as the owner have limited liability for what happened to the business so if the business gets sued if it has a lot of debt without it has to go bankrupt it is separate from you and they're not going to come and take your own money and take your house Etc unless they can pierce the corporate Bill and we're going to talk about that in a minute like a partnership in that Partnerships have a lot of flexibility how you structure it so let's say you start a business with two other people you and one person are going to actually run the business the third person is really just a passive investor they're just giving the money and they just want somewhere to return well it doesn't make sense for them to have control in the business and and need to be running business on a daily basis because they're just wanting to invest money so with a partnership or a limited liability company you can structure it such that the two people are going to manage the business on a daily basis and then the other partner is just a passive investor and they don't really have control over what happens on a regular basis you're only going to go to them for big stuff like you're going to sell the entire business things like that now you can have an LLC that just has one owner this was something that years ago was a big debate because since an LLC is kind of like a partnership people are like well you can't be partners yourself that makes no sense but the law is settled on this you can have an LLC with one owner now there's you'll see some stuff out there that there are problems with having LLC with one owner and I'm not going to go into all the legal details of that because that's like way too much unless you're really interested in it but the bottom line is if you are honoring the corporate LLC phonies in this case and you are not and you're not trying to like use this LLC to like you know mess with people and to to hide money in a like fraudulent kind of way then these kind of issues are really not going to apply to you they apply to people who set up a whole bunch of different llc's and are hiding money and moving things around this kind of shell game as a way to defraud people and maybe not pay taxes you know things like that and I say not pay taxes I don't mean being strategic about lowering your taxes I mean tax fraud which is a very different thing so hopefully you are watching this video you're not going to be using your LLC to do fraud on people or to try to hide money in some kind of a legal way you're just you know having an ordinary business so that's not going to be the trouble that you're going to go into the problem that can happen with llc's is that because they're less formal because you don't have bylaws and minutes of your annual board meeting and all this stuff it can end up being too informal especially if there's just one owner or there's maybe just you know two or three owners and they're in a relationship like a personal relationship too so they tend to be more casual about things in this business the issues with the LLC like I said you have to honor corporate formalities and I would actually be doing a video specifically about how do you actually honor corporate formalities but you have to keep the business separate from yourself it has to have its own checking account if they keep track of money in some kind of bookkeeping system you can't just take LLC money and pay for your own personal stuff okay everything has to be done with paperwork everything needs to be formal when you pay yourself in reality you don't just use the LLC money to go buy groceries for yourself you have your LLC pay you money into your personal checking account and then use your own money to buy the groceries and yes is that tedious sure is that extra paperwork sure but the thing is it's not that tedious and if you don't do it you might as well not even informed this LLC because it's going to be as if it doesn't exist because it's your Alter Ego it's you're just treating it as an extent attention of yourself so you still have to honor those formalities even they're really tiny formalities so it's really not going to be that hard to do there's a tiny bit of tediousness but it's not that much another wonderful benefit of an LLC is tax planning so the default if a one person forms an LLC is that it's taxed as a sole proprietorship if two or more people form an LLC the default is as tax as a partnership that can be the right tax status especially in the beginning especially if you're taking a loss But as time goes on and you're making more money in this business it's it's paying out more profit you're probably going to want to do some more sophisticated tax funding and so because of this you could have an LLC that is taxed as a corporation it can be taxed as an S corp if you're eligible for that or tax as a C Corp that means you get the benefits of an LLC with having less paperwork to do with the benefits of a corporation having more sophisticated tax planning and as a way to potentially save money on taxes now unlike a sole proprietorship or partnership to form an LLC you actually have to form it with a state so in the United States LLCs are not formed on a national level or a federal level they're formed at a state level so you have to pick a state now what state you should pick really depends on your exact situation but if you're residing in the United States most of the time it makes sense to pick the state where you reside because you're going to have to file a bunch of stuff there anyway and you don't want to file another state and your state occasionally if you have a business that is a hundred percent virtual it is possible and no employees physically working there et cetera sometimes you can have it formed in another state besides the one you live at but if you end up performing having it be taxed as an S corp and you pay yourself as an employee you're gonna have to register in your own State anyway so for a lot of situations this doesn't make a lot of sense if you are outside the United States if you reside outside the United States then you can pick whichever State you want if it you have a state where you have physical connections you have employees there you have inventory then I'd probably pick that state because you have to register there anyway if you have it's all completely 100 virtual let's say you're selling eBooks you know something that is 100 virtual then you can just pick whichever State makes sense so people usually pick states that have low cost and that are are easy to form things so Nevada has been a classic one a lot of people pick Wyoming they've set up a lot of things there and there's also been other states that have been getting into this game of setting up llc's as a way if I think for the state to make money so people are setting up llc's in New Mexico and Montana and in other states as well the the bottom line is if you are starting a business and you want to protect yourself from the business you if the business gets sued or goes bankrupt or whatever you don't want to personally be on the line an LLC is a very good thing to consider consider as a great option for you the one time that that's most common where it doesn't make sense is if you're outside the United States having an LLC may be difficult for you to deal with because they don't have llc's in your own country and but or if you're doing business with people in a lot of different countries in that case it may makes more sense to set up a corporation because you want something that everyone will understand and it'll be easier for people in your own country your accountant Etc to handle the paperwork for that versus if you have an LLC and they don't even know what you're talking about the same kind of thing if you're doing business people in other countries they'll understand what a corporation is but they may not get what an LLC is again this is attorney Elizabeth potts-weinstein if you have any questions about what we've talked about today feel free to post them in the comments below and I'll try to point you in the right direction thumbs up if you found this video helpful subscribe for more videos like this and if you found this video especially helpful for you you can always join the Discord or sign up for the patreon information about that is in the description below thanks a lot for watching talk to you next time bye