Most business owners are lost when it comes to managing and understanding business entities. If you’re not, then you’ve probably done some extensive research at some point in time (or you have a great business lawyer on-call!).

Let’s set the record straight on the top three LLC questions that clients frequently ask:

1.  What exactly is an LLC?

LLC stands for limited liability company. A limited liability company is a product of state law, so how they are formed and how they are treated (by the state) after creation varies state-to-state. There are three legal ways to look at LLCs – from the state, from the IRS, and from the courts.

• State.  When you create an LLC, what you’re really doing is asking the State to recognize this new entity as a legal “being” – it’s akin to filing for a birth certificate, but in a business sense. Once you’re certificate of formation is filed and accepted by the TX Secretary of State, congratulations! You are now the proud parent of a brand new LLC “baby.”

• IRS.  Once the State has recognized this new entity, the IRS needs to know what to do with it. Because LLCs are creations of the states and vary between states, the IRS does not actually recognize LLCs as a new kind of creation. LLCs get to tell the IRS how to treat them for taxation (corporation, partnership, or sole proprietor). This is a decision that is best made with a tax professional, but does not affect the actual structure or daily operations of the company.

• Courts.  Every business owner hopes that he or she doesn’t have to end up in court over a business dispute, but about 70 percent of all businesses in the United States find themselves engaged in litigation every 10 years. Even though the State has recognized an LLC as a separate entity, and even though the IRS knows how to tax it, the courts have an entirely separate discretion to “disregard” your LLC and treat your or your partners as a sole proprietor or a partnership with no “liability shield.” This is where maintaining LLC records and following other basic procedures in your company can help prevent piercing of an LLC’s liability shield.

2. Why do I need to form an LLC?

In most cases, there is no reason for a business owner to form anything other than an LLC. The creation of the LLC has made most other entity choices obsolete for most small businesses. An LLC can be treated essentially as it chooses for taxation, it has the same liability protection as a corporation, and it requires much less effort to maintain compared to a corporation.

The main reason to form an LLC is limited personal liability. Aside from a few exceptions and if an LLC is run correctly, the owner’s personal assets are protected if someone sues the business and the business assets are protected if someone sues the owner. The same holds true for creditors of the business and the owner.

I think we can agree, too, that there’s an element of instant street cred for operating as an LLC instead of a sole proprietor. Your signs look fancier. your business cards look nicer, and your possibly-obnoxiously wrapped truck can even seem a little more legitimate.

3.  Once the certificate of formation is filed with the SOS, what’s next?

You are not done! the certificate of formation is enough to get the state and the IRS to (initially) recognize your business as a separate entity, but it is not enough for long-term recognition and it’s certainly not enough to please the courts. That veil will be pierced if all you do is file a certificate of formation!

The State of Texas has a book-long statute telling you how your entity will be run if you don’t create a writing that says otherwise. Running your LLC under these rules is about as awesome as dying without a will. I, personally, am way too much of an anarchist to let the state dictate how my company will be run or how my money and my kid will be cared for after I die. So, what needs to be done?

• Company Agreement.  The company agreement is a document that explains how you will run your business. This document usually creates offices, names the members and their respective shares in the company, dictates how and when meetings will be held, etc. As a side note, with an LLC the standard president, vice president, secretary, and treasurer that are required in corporations can absolutely be replaced by replaced by any title and authority that works (or amuses) the business owner. If a business owner wants an official title of “grand supreme master,” “ruler of the world,” or “honey badger,” we can make that happen!

• Organizational Minutes.  The initial member(s) will also need to hold an organizational meeting and keep minutes (or draft and sign a consent in lieu of such meeting). These minutes will appoint the officers, give the company authorization to open a bank account, adopt all actions taken on behalf of the company thus far, etc..

• EIN.  Once the operational docs are complete, the company will most likely need an EIN. This goes back to the “how does the IRS see my entity” question, but the actual application for the EIN is quick and painless.

• Franchise Tax.  Texas has a franchise tax return/public information report that is due every year for every entity organized in Texas. period. Even if the business doesn’t owe any franchise taxes, a form must be file every year. Failure to file annually is probably the fastest and most common way that an entities’ statuses are revoked or suspended.

• Updates and Follow-ups.  The SOS must be updated with any changes in a business’s registered agent (which really should be the business owner), address, ownership, and assumed names. Registered entities are required to file DBAs in their principal county and with the secretary of state.

• Total Separation.  The most common and probably most detrimental operational mistake we see is a failure on the part of the business owner to treat the LLC like what it is – a totally separate entity. If you treat the LLC like you are the LLC, so will the courts. This means, among others, keeping the business owner’s finances separate from the LLC’s, not reaching into petty cash to pay for coffee, and always signing agreements in the name of the LLC (in the officer/member’s capacity). A good test is to determine whether the action would be allowed by an employee of a company, all corporate red tape aside.

While the information contained in this post touches on various LLC ideas, it is not a comprehensive list. This information is for educational purposes only and is not provided as legal advice. Do not substitute any information on this page for the advice of a lawyer with whom you have an attorney-client relationship. Nothing on this page creates an attorney-client relationship between The Olson Law Firm/Lindsey Olson and any other person.