Wednesday, January 18, 2012

Forming a California Limited Liability Company - Mistakes to Avoid

Are you an investor or entrepreneur setting up a limited liability company for a California venture? Your decision probably makes good sense. An LLC reduces your legal risks and (usually) minimizes income and payroll tax expenses. But be careful! You want to avoid three common incorporation boo-boos:

Mistake #1: Ignoring the Franchise Tax

Limited liability companies deliver big benefits in terms of minimizing legal and business risks and in terms of grinding down your business taxes.

If you own a business or investment through an LLC, for example, you're not (and other owners won't be) liable for the LLC's debts or other obligations merely because of your ownership.

Furthermore, limited liabilities companies offer huge tax accounting benefits, including the ability to elect the tax treatment you want for the LLC: sole proprietorship, partnership, c corporation, S corporation, and so on.

Unfortunately, the state of California (rather uniquely among states) reduces the attractiveness of the LLC option. The state levies an annual LLC tax on limited liability companies. At a minimum, this tax equals $800, but the hit goes up based on the business's income rises.

The LLC franchise fee is significant for many small investors and micro-businesses. Accordingly, make sure if you're thinking about forming a limited liability company that formation still makes sense once you consider the extra state taxes you pay as a result.

Many very small investments and businesses, very frankly, probably can't justify paying $1,000 or more for the benefits the LLC option delivers.

Mistake #2: Planning for Quick Setup

Another mistake related to forming an LLC in many states - including California - is this: State government offices that process LLC applications are now taking longer and longer to stamp the paperwork "approved." And that means you need to plan ahead and factor the delays into your business and investment plans.

In mid-to-late 2010, for example, the California Secretary of State says that processing the articles of organization for a limited liability company requires roughly sixty days. That's actually pretty brutal: If you want to operate your business as an LLC, you'll going to have to wait almost two months just to get the business or investment entity setup.

Mistake #3: Using a Nevada Corporation or LLC

Another blunder to avoid like the plague is incorporating in Nevada or some other "business friendly" state like Delaware.

With the massive hassle-factor of incorporating California limited liability corporation, you might wonder whether you can just go next-door to Nevada.

Another state's fees and taxes are almost always going to be lower than California's. And many states quickly process business formation documents because they realize that doing so benefits everybody.

But practically speaking, you can't simply "opt" for incorporating in another state. If you're operating your business or making an investment in California, you either need to use a California LLC or corporation... or if you've initially setup up a corporation in another state (like Nevada) you'll need to register your Nevada entity as a foreign corporation or foreign LLC operating in California.

Registering a "foreign LLC" or "foreign corporation" in California, however, puts you right back at square one: Registration of the foreign corporation takes months and triggers the annual franchise fees and taxes.

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