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Written by : Hollis Bemo
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as of 2021 there are 31.7 million business owners in the united states many business owners are setting up llc's one out of every six taxpayers that comes to my office owns an llc i own six llc's and i've set up over 5 000 llcs for my clients l to the l to the c i love saying llc because it reminds me of ll cool j llc's are the most popular business vehicles that business owners set up why is it that most business owners who have llc's aren't sure if they should be in llc's my name is carlton dennis and in today's video we are going to go over what you need to consider before setting up an llc llc owners make a lot of mistakes i'm sorry and in today's video i need to point out some of the mistakes that you need to be conscientious of before establishing your llc let's dive in mistake number one is not knowing the type of income you're receiving prior to setting up your llc this is really important and reason why is because there are three different income types you could be receiving and it could determine whether or not you need an llc versus an s corp or a c corporation the three different income types that you need to be familiar with are number one ordinary income ordinary income is everyday income that you work for and is typically in the form of w2 wages or 1099 compensation the next form of income is passive income passive income is income you technically do not have to work for typically you're familiar with passive income from investment properties or interest that you earn off of the money that you have in your bank account the third type of income is portfolio income portfolio income is typically income that you receive when you decide to sell capital assets or if you have capital gains tax from the sell of a rental property these three types of income are important for us to know because it can help us decide whether or not it makes sense for us to have an llc so let's talk about it number one passive income if we have passive income what we have to understand is that passive income is not subject to social security tax or medicare tax that ordinary income is subject to so when you think about it it may not make sense for you to worry about whether or not you have to eventually transition your llc to an s corporation if you have rental real estate if your income is passive you don't have to worry about self-employment tax so typically a lot of real estate investors will establish llc's for their real estate holdings so if you ever had the question in your head why do people set up llc's as opposed to c corps or s corporations for their real estate a big deciding factor around this is because real estate investors are not subject to the social security and medicare tax that ordinary income earners are subject to this leads me to ordinary income ordinary income is the income you're familiar with when you're working a job where you are putting in labor anytime you're putting in labor you're going to have to pay into social security and you're going to have to pay into medicare taxes and if you decided to become a business owner that means you pay into self-employment tax it's been talked about in all of my youtube videos if you've seen them now one thing that you have to understand about ordinary income is that ordinary income you will pay 15.3 self-employment tax which is your social security and medicare but then you will also pay your federal taxes and your state taxes so knowing that ordinary income is subject to self-employment tax federal tax and state tax we have to define what type of business owners need to know that their business is actually ordinary income instead of passive business let's talk about that i have clients all the time that'll get on the phone with me and tell me carlton i have a passive business i started amazon automation i'm doing amazon fba i'm selling products on etsy i have my online shop any of these clients that i talk to that have these businesses that are very automated had to work to get to a place where their businesses are automated they sat on the computer they figured out how to put up ads build their website hire the contractors and someone else is doing the fulfillment and dropping off the orders to the house that is a business that requires work and if labor is involved we are subject to social security and medicare taxes federal and state taxes so i just wanted to make sure that when we go into setting up a llc that we also understand which type of businesses are ordinary income businesses and truly understanding what would be considered a passive business last but not least is portfolio income i don't really get too much into the portfolio income unless i'm dealing with my real estate investors which i primarily focus on if you happen to have real estate income and you decide to sell an investment property you're dealing with capital gains it could be short or long-term capital gains depending on how long you held on to that asset but if you're aware of capital gain income you might realize that this is actually categorized as portfolio income to your tax account so understanding these three types of income can let us know whether or not you should have an llc that's going to remain as an llc or if you have an llc that will eventually be switched to an s corporation or another desired entity structure mistake number two with llcs is not establishing your llc prior to knowing that you wish to have a real estate acquisition it comes up pretty often that i get on the phone with a client that told me that they just bought an investment property and now they're trying to decide whether or not it makes sense for them to have an llc and i sometimes wish that they would just have a conversation with me prior to them buying the rental property because then i might have advised them to establish the llc prior to buying the rental property so that they can buy the property in the name of the llc that they establish for themselves this is a way that we can completely avoid having your name ever online at the accounting assessor's office saying that you're on title for owning the property but then we get to a place where you want to have that asset protection because you find out that someone could slip and fall and hurt themselves inside of your property so you eventually want to have an llc for liability protection but the property is already in your name so now we have to decide does it make sense to set up an llc and do a quick claim deed and re-title your property in the name of the llc well this is where we can run into some issues at least i've had clients run into issues one of the issues that they run into is this whole do on sale clause where now there's a stipulation in their mortgage agreement that says that anytime a property is being transferred or sold that the mortgage is now due so this is where we have to be extremely careful and mindful prior to establishing llc's into investing in real estate we have to speak with the tax pro we have to speak with our mortgage company we have to determine if we can purchase a rental property in the name of an llc and if you're setting up
Thanks for your comment Brooks Healey, have a nice day.
- Hollis Bemo, Staff Member
are you thinking about starting a business in 2020 well today I'm going to teach you the five things that you need to know to help you decide whether or not an LLC is the right entity choice for your business let's do this hi my name is Jim Hart and I am your online business lawyer I'm here to teach online entrepreneurs and small business owners what they need to do to protect their business so they can focus on what they do best and that is building something that truly matters in the world today we're gonna be talking about five things that you need to know about LLC's to help you decide whether or not an LLC is right for your business so let's get into it number one let's start with the historical context behind LLC's so LLC's were started in Wyoming way back in 1977 and they were started as a way to bridge the gap between the traditional corporation and the partnership there's a lot of benefits to both of those entities but sometimes the things that you get from a corporation are not necessarily the things that are helpful and some of the disadvantages to a partnership are things that you would need a corporation for so so basically the Wyoming legislature decided to merge those two things into an entity called the limited liability company now when this was initially formed the IRS didn't know what to do with it because they didn't know how to tax this entity because it was something completely new and unique that nobody ever seen before and so for a while they tried to tax them as corporations then they had some tests that they evolved to decide well maybe we'll tough to tax them as a partnership or a sole proprietorship we weren't really sure what to do up until about twenty years later in 1996 the IRS figured out that we'll just say you know what you decide how you want to be taxed and at that point there have been a couple other states that enacted statutes for their own limited liability companies by 1996 all 50 states have enacted statutes that allow for the creation of a limited liability company now the one thing you need to know is a limited liability company is a state specific entity which means it's not a federal thing this is a state specific thing so each state is different each state is unique and I've talked about this before in other videos but it's really important that you understand that in most cases I would say in 99% cases you're gonna want to form your business entity if you do decide to go with an LLC in the state where you live now if you have questions about the specific requirements in your state you're gonna need to direct them to an attorney who is licensed in your state but today's video we're just gonna talk a big-picture the things that you need to know that are generally specific to pretty much all 50 states when it comes to limited liability companies alright so number two let's talk about what is an LLC well let's talk about what an LLC is not it is not a corporation it is a company that is organized to provide limited liability to its members who in the case of an LLC are not considered shareholders they're called members those are the owners of the LLC that is a really important distinction that you must be aware of if you decide that an LLC is the right entity for your business in general LLC's are much more flexible than corporations this is in large part because you can draft an operating agreement that dictates how you're going to run your business and all the rules that you're going to follow and this operating agreement can supersede the state statute that the govern how LLC's are to be run so basically what this means that is if you do not have an operating agreement then your LLC is going to be governed by your state statute wherever you have formed your LLC those are gonna be the default rules and I would tell you nine times out of ten those default rules are not going to be sufficient for you with a little water today so where was I basically if you do not have an operating agreement in place then the default rules in your state are gonna dictate how your LLC is going to be governed and how it needs to be run as I was saying nine times out of ten those default rules are not going to be sufficient for what you're trying to do with your LLC so in most cases you're gonna want to have a rock-solid operating agreement in place that is going to be the bedrock of your limited liability company because it's gonna be basically the foundation that can provide all the rules procedures and things that you need to know to run your business effectively alright so number three let's talk about how an LLC differs from a corporation and there's a number of different ways it differs we've already talked about flexibility an LLC is much more flexible than a corporation we've talked about the names of the people that own the business with an LLC we're talking about men with a corporation we're talking about shareholders or stockholders when you're talking about an LLC the officer director of the equivalent of that so for time I'll step back for a corporation you have officers and directors those are the the officials that run the business that are separate apart from the shareholders so you have centralized management that's one of the core fundamental principles of a corporation with an LLC you don't necessarily need to do it that way but you can and if you do decide to have centralized management what you would have our managers and so that would be a manager man managed LLC versus a member managed LLC and that is a core distinction that a lot of people don't really understand and don't really consider when they're setting up their operating agreement so when you form an LLC you get a membership interest in the LLC or a certificate of membership versus a stock certificate or a stock in a corporation if you have a corporation when you distribute profits those are called dividends with an LLC and you distribute profits they're gonna be called distributions now some people will call them dividends and things like that but the the legal term will be a profit distribution when you have an LLC when you form a corporation you file with the Secretary of State's office in your state what are called Articles of Incorporation when you have an LLC you're going to file articles of organization that are telling the state that you're organizing your company as a limited liability company we've talked a great length about the importance of having an operating agreement when you when you have an LLC if you have a corporation the the similar document that you're going to have that are called the bylaws of the corporation now finally one big thing that an LLC has that a corporation does not have is what is called charging order protection this is really important and something that a lot of people miss and what that means if you if you have an LLC and you have this charging order protection that is going to protect the LLC from the member creditors in other words the people that a member of the LLC might owe money to they can sue the LLC to get it that membership interest but all they can get is what's called a charg
Thanks be4dum your participation is very much appreciated
- Hollis Bemo
About the author
I've studied interactionism at Allen College in Waterloo and I am an expert in marxist sociology. I usually feel ditzy. My previous job was photographic equipment mechanic I held this position for 24 years, I love talking about swimming and bonsai. Huge fan of Lauren London I practice motocross racing and collect books.
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