If you are a husband and wife looking to start a joint business and are considering a limited liability company (LLC), you can do so just as you would form any LLC, or choose to form a Family LLC. You just need to be aware of the tax implications before you do so.
What is an LLC?
An LLC is an increasingly popular business structure for startups, offering liability protection for ownership and greater flexibility than a corporation, particularly in terms of taxes. The LLC itself does not pay taxes. As a “pass-through” entity, income passes through the business to the owner or owners, who report it on their personal tax returns. An LLC is created by filing paperwork with your state, and nominal fees are involved.
An LLC offers its owner or owners, who are called members, considerable flexibility in terms of management. You can choose your management and operational structure and decide how you want to be taxed. Your LLC can have a single member or multiple members, all of whom have personal liability protection, meaning your personal assets are not at risk if you cannot pay business debts or are involved in a lawsuit.
A Family LLC is a way to protect assets against liability, distribute them to heirs, and avoid probate. Members must be related by blood, marriage, or adoption.
A Family LLC is formed with the state, with one member designated as the managing member. The LLC will have an operating agreement that specifies rights related to ownership, how assets will be transferred, and how the LLC will be managed. Family LLCs can be used for business purposes including real estate or brokerage account assets, but a personal residence cannot be managed by a Family LLC.
A Family LLC can protect the family’s assets from the claims of creditors, but that protection is limited to the amount of each member’s financial contribution to the LLC.
The tax benefit of a Family LLC is that the value of assets transferred to heirs can be reduced by up to 40% of their market value, therefore reducing estate tax liability. It also reduces gift taxes when you distribute assets to your heirs during your lifetime by placing them in the Family LLC.
Family LLCs are often used in estate planning because of the asset protection and tax benefits. It is also a way to keep assets in the family.
Tax and Other Implications
If both husband and wife are involved in the LLC, having both of you as members protects both your personal assets from liability. You may, however, have to be taxed as a partnership or a corporation rather than a sole proprietorship depending on your state of residence. If your state is a community property state, you can generally be considered a single-member LLC even if you’re both members.
If you are married, but file your personal taxes separately, each of you will need to report your share of profits or losses from the LLC on your personal tax return.
How to Form an LLC
- Choose Your State. The first step is to choose the state in which you plan to do business. LLC processes and requirements vary by state, so visit your state’s website for details. Generally, you can form your LLC with an online application. If you plan to have physical locations in more than one state, you will need to register a foreign LLC in the states where you will do business other than your home state.
- Choose Your LLC Name. Your business name is extremely important. It should reflect the brand you plan to build, tell customers what you do, and be memorable. Once you’ve chosen a name, you’ll need to make sure that it’s not already taken. You can do a search on your state’s website, and on other state websites if you are doing business in more than one state. You should also check the US Patent and Trademark Office to make sure the name hasn’t been trademarked.
- Choose a Registered Agent. A registered agent is the person or company that sends and receives legal documents on behalf of your LLC. The registered agent can be a member of the LLC, or you can choose a third party such as an attorney, or a company that offers registered agent services. Most states require you to have a registered agent. The agent must be a resident of the state where you do business, or a corporation authorized to do business in your state.
- Determine Your Management Structure. There are two types of management structures:
- A Member-Managed LLC is managed by the members of the LLC. This is usually chosen by smaller LLCs with few members who will be involved in various management roles.
- A Manager-Managed LLC is managed by people who are not members of the LLC and are employees of the business. This structure is often used when an LLC is larger and has multiple members.
- File Articles of Organization. The articles of organization is the form you fill out to create your LLC. These forms vary by state but can generally be filed online. You’ll need to fill out the LLC name, the name and address of the registered agent, the names of the LLC owners, and in some states, the way the LLC will be managed. Fees are generally around $100.
- Draft an Operating Agreement. An operating agreement is not usually required but is highly recommended. The operating agreement should clearly define the following:
- The percentage of each member’s interests in the LLC
- How profits and losses will be allocated to each member
- Each member’s rights and responsibilities
- The management structure and management roles of members
- The voting rights of each member
- Rules for meetings and voting
- What happens when a member sells their interest, becomes disabled, or dies
It’s a good idea to have an attorney’s help when creating your operating agreement so that you can be sure you’re covering all bases to protect all members and avoid future issues.
- Apply for Business Licenses. It’s important to make sure you’re in compliance with all laws at the local, state, and federal levels. It’s likely, depending on your location and type of business, that you’ll need business licenses and permits. Do some research to determine which licenses you need. At the very least you’ll need a sales tax permit to sell products and collect sales tax.
- Obtain an EIN. EIN stands for Employer Identification Number and is like a social security number for your business, allowing the IRS to identify your business easily. It is also known as a Federal Tax Identification Number (FTIN), or sometimes for corporations a Tax Identification Number (TIN). An EIN is required if your LLC has more than one member, if you plan to hire employees, or if you choose to have your LLC taxed as a corporation. The application is free and can be found on the IRS website. The application is form SS-4, and it can be mailed to the IRS or submitted electronically, and once your information on the application has been validated, the EIN is assigned immediately.
- File Annual Reports. Your state may require you to file annual reports for your LLC, which may involve a fee. Check your state for requirements.
Benefits of Forming an LLC
- Simplicity. An LLC is simple to form, requiring much less paperwork than a corporation. You only need to file Articles of Organization and have an Operating Agreement to define ownership and roles and responsibilities. There’s no annual meeting or reporting requirements, as with a corporation, and you don’t need a board of directors. In some states, however, you do have to file an annual report for an LLC. It’s also less expensive to form an LLC. Corporations and partnerships are best formed with the assistance of an attorney, which is expensive. It is a good idea, however, to have your LLC’s operating agreement reviewed by an attorney. Corporations also pay fees for their required annual filings.
- Control. In an LLC, you can be the only owner just like a sole proprietorship so that you have full control of the business. If you have more than one owner, you can structure the management any way you choose with your operating agreement. You don’t have to answer to a board of directors or anyone else. You have more freedom to make decisions than you do in another type of business structure, other than a sole proprietorship.
- Limited Personal Liability. Unlike a sole proprietorship, an LLC is considered a legal entity that is separate from you, as the owner. Just as in a corporation, your personal assets are protected because you are not personally liable for the company’s debts or legal liabilities. In a sole proprietorship or general partnership, your personal assets such as your home are at risk if there are unpaid debts or legal liabilities. There are some instances in which an LLC owner, however, could have personal risk. For example, if you are asked to personally guarantee a business loan, you are personally liable for the debt.
- Tax Advantages. An LLC is considered a “pass through” entity, meaning income passes through the business to the owners for tax purposes. The LLC is not a taxable entity, so all income is reported on the tax return of the owner or owners and taxed at their personal income tax rate. In the case of corporations, the corporation is taxed as well as the dividends shareholders receive, which is sometimes referred to as double taxation. LLC owners also may be eligible for the 20% pass-through deduction that was part of the Tax Cuts and Jobs Act, meaning they can deduct up to 20% of business income. An LLC, however, can choose to be taxed as a corporation or partnership if it is deemed to be beneficial for the company.
- Profit Sharing Flexibility. Most businesses split profits based on the capital contributions of owners. In a partnership, profits are generally divided equally. Corporations pay dividends based on the ownership percentage of the shareholders. In an LLC, in the operating agreement the owners can specify any profit-sharing plan that they choose. One owner can take a percentage share of profits greater than their ownership interest, while other owners take less. This may be done in a case in which one owner is more involved in the operations of the business than others.
- Credibility. An LLC has the advantage of having more credibility to customers and vendors than a sole proprietorship. As a matter of perception, people tend to see an LLC more as a more established company, as opposed to a one-person show.
Whether you as husband and wife plan to work together or are forming an LLC for estate planning purposes, it’s easy to do. You may want to consult with a tax professional or an attorney before doing so, however, to make sure it’s the right choice for both of you. If you’re forming an LLC for estate purposes, you may have options that are more beneficial. It’s best to have a professional assess your particular situation and advise you on the optimal choices.