6 LLC Formation Mistakes to Avoid

Business is booming in the U.S. and around the globe. According to the U.S. Census Bureau, application numbers doubled in 2020 compared to recent years, and over 5 million applications were filed in 2021 and 2022. The trend accelerated in 2023, with 5.5 million new business applications filed.

Forming a Limited Liability Company (LLC) is an attractive business structure for many. It also makes it possible to protect personal assets while in business. However, creating and maintaining a successful LLC can be challenging.

Understanding these pitfalls and implementing best practices is important. That creates a solid foundation for growth. Are you an entrepreneur or planning a multi-member LLC? This article will give you the knowledge you need.

6 Mistakes To Avoid When Forming An LLC

Before discussing the strategies for success, you should understand the pitfalls. This will help you avoid them and keep your business on track. Consider these six mistakes.

1. Not Creating An Operating Agreement

This document outlines your company's ownership structure and member responsibilities. Without it, you're leaving your business vulnerable. Disputes and potential legal challenges can become much more difficult to manage.

An operating agreement describes how your LLC will run and clarifies decision-making processes and procedures. For example, let's say you start a consultancy LLC with partners. You need to define what will happen if one partner decides to leave.

An operating agreement can also benefit single-member LLCs. It adds separation between personal and business. It can also be important for funding or selling. A structured operating agreement can give others confidence in the business and show that you’re taking the venture seriously.

2. Mixing Personal And Business Finances

Combining personal and business finances is a mistake. This can pierce the corporate veil. It can threaten the limited liability protection that comes with this business type. That said, it’s easy to make this mistake.

Imagine you run a small graphic design LLC and use your own credit card to buy software. This blurs the lines between personal and business, which may cause a problem if your LLC faces a lawsuit. It could also allow others to go after your personal assets.

A NerdWallet survey of over 300 U.S. small-business owners gave some insight into how most business owners manage this. 96% say they have a business banking account. Over a third of those business owners have accounts at two banks.

To maintain the separation between your personal and business finances:

• Open a dedicated business bank account and credit card
• Use these exclusively for business transactions
• Avoid using business funds for personal expenses
• Keep records of all financial transactions
• Pay yourself a salary or a fixed amount on each project

Maintaining a clear financial boundary protects assets and simplifies accounting processes. This can make tax time much less stressful and present a more professional image.

3. Not Paying Taxes

LLC owners need to make quarterly estimated tax payments. If you don’t, you could face penalties. For example, interest charges from the IRS. The late payment penalty is 0.5% of the tax owed after the due date, for each month or part of a month the tax remains unpaid, up to 25%.

Not staying on top of this can jeopardize the business. But some new business owners don’t know about setting aside money for taxes. When tax season arrives, they could owe thousands. Plus, they need to manage those penalties for not paying quarterly taxes.

To avoid this mistake:

1. Set aside a portion of your income each month for taxes
2. Make note of quarterly tax due dates
3. Make timely payments
4. Consider using accounting software

You can also set up a separate savings account for tax payments. Research your tax rate. This will help you see how much money you should set aside from each transaction. That way, you have the money come tax season.

4. Ignoring State-Specific Requirements

There are federal and state regulations for LLCs. Ignoring the state-specific requirements can lead to fines. Or worse, involuntary dissolution of your LLC. You need to know how to stay compliant.

For example, section 206 of the New York State Limited Liability Company Law requires that within 120 days after the effectiveness of the initial articles of organization, a limited liability company (LLC) must publish in two newspapers a copy of the articles of organization or a notice related to the formation of the LLC. Otherwise, you may not be allowed to operate.

But you can avoid issues like this by:

• Researching your state's unique regulations
• Filing annual reports
• Maintaining a registered agent.
• Staying informed about local business license requirements

By meeting these state-specific obligations, you keep your LLC in good standing. It also helps you avoid compliance issues. Consider setting up automated reminders or working with a licensed attorney for legal advice. This may keep important tasks from falling through the cracks.

5. Not Keeping Accurate Records

Not maintaining accurate and up-to-date records can lead to tax complications and legal issues. It may even cause you to miss new business opportunities. Having organized records can protect your small business and position it to grow.

According to the IRS, you must keep your business records available at all times for inspection. If the IRS examines any of your tax returns, you may be asked to explain the items reported. A complete set of records will speed up the examination.

How can a lack of records stop your growth? Imagine a small construction LLC in Texas. The owner may be very skilled in the trade. However, a lack of records could hold them back from major revenue. This may disqualify them from things like government contracts.

To avoid records problems:

1. Implement a system for tracking all financial transactions
2. Keep detailed minutes of member meetings
3. Hold on to copies of all important business documents.
4. Consider using accounting software

Maintaining records helps you be compliant with regulations. It can also give you insights into business performance. That may empower you to make better decisions about your next business move.

The income statement is one of the core financial statements for a business. Download an income statement template with multi-step and single-step variations.

6. Misclassifying Employees

The difference between employees and independent contractors is important. Some LLC owners mistakenly treat employees as contractors to avoid payroll taxes and benefits, but this can backfire.

For example, a software startup could classify all workers as independent contractors. If one of the programmers files for unemployment, it could trigger an audit. If that audit finds that the programmer should have been classified as an employee, the business will face penalties.

To avoid this mistake:

• Understand the criteria the IRS uses to determine worker classification.
• Consult with a labor law firm or tax professional
• Regularly review your workforce classifications

In 2020, a major ride-sharing company faced a large lawsuit for misclassifying drivers as independent contractors. Massachusetts Attorney General Andrea Joy Campbell argues that drivers for Uber and Lyft are employees under state law and therefore entitled to benefits such as a minimum wage, overtime, and earned sick time. This issue is ongoing.

Her office claims the companies for years misclassified thousands of Massachusetts drivers and cannot meet a three-part test under the state’s worker-friendly laws that would allow them to be deemed independent contractors

By correctly classifying your workforce, you can avoid several different issues. All creating a fair and compliant work environment. That protects the business entity and it may improve worker satisfaction.

What are the basic elements for creating an accurate and compliant payroll tax system? Check out this article to understand small business payroll taxes and the resources available to help you stay on track.

5 Tips For Successful LLC Formation

Now you know the pitfalls to avoid. But what can you do to get on the right track at the start? Use these tips.

1. Choose The Right Business Structure

Selecting the appropriate business structure makes all the difference. It impacts everything from tax benefits to operations. Every business is unique. So there are several factors to consider before you make a choice.

When choosing your structure:

1. Assess your business needs and goals
2. Think about your future plans
3. Consider your tax returns
4. Evaluate your liability needs

This can lead you to the right conclusion. A freelance graphic designer might decide a single-member LLC is the best fit. A tech startup with plans to seek venture capital might decide they need to choose another business structure like a C-corp. Others may choose an S-corp.

You may also consider working with a business attorney or tax professional. They can help you evaluate your options. You can change your business structure later. However, it can be a lengthy process. That’s why it is best to make an informed decision right when you form.

2. Use Professional Services

It’s tempting to handle everything yourself to save money. However, using professional services can save you time and prevent costly LLC mistakes. Think of it as an investment in your business's future—not an expense.

These are professional services to consider:

• Accountant: Can help set up your financial systems
• Business attorney: Can review contracts
• Registered agent: Can ensure you receive all important business documents
• Business consultant: Can offer valuable insights on market trends, and operational efficiency
• Insurance broker: Can help you understand and get the right insurance

Having a relationship with a business attorney can be helpful in industries with many regulations. They can review contracts and help you understand your responsibilities. They can also negotiate fair terms

Appointing an individual as your registered agent is an option. However, using a professional registered agent service offers some advantages. They can make it easier for you to keep up with annual report filings and state requirements.

Services like these come with upfront costs. But, they often pay for themselves by supporting your LLC's success. They take the pressure off of the business owner and allow them to focus more on what they do best.

3. Review and Update Your Business Plan

Your business plan shouldn't be a static document. It should evolve with your business and market conditions. Regular reviews and updates keep your LLC agile. It allows you to be proactive as circumstances change.

To review and update your business plan:

1. Set aside time quarterly or bi-annually for a review
2. Assess your progress towards goals and adjust as needed
3. Analyze market changes and trends
4. Compare your financial projections to results
5. Reconsider your marketing strategy.

For example, you may do pulse checks on a monthly basis. This allows you to review key metrics against the business plan, which can help you stay ahead of market trends and uncover potential problems.

Your business plan is a tool. It should help you make informed decisions and keep your team aligned on your goals and strategies. This will keep your LLC running smoothly.

4. Take Advantage of Tax Deductions and Credits

One of the perks of running an LLC is tax savings. If you don’t maximize these benefits, you’re leaving money on the table. Smart tax planning can impact your bottom. It can also free up capital for growth.

Consider focusing on these areas:

• Home office deduction
• Travel expenses
• Professional development
• Health insurance premiums
• Retirement contributions

Imagine that a photography LLC in New York keeps records of equipment purchases. They also track mileage to and from photoshoots and claim a portion of their rent for their home studio space. By maximizing these deductions, they've been able to invest more in high-quality equipment. That can improve the quality of their work and attract higher-paying clients.

Remember to research industry-specific tax credits that might apply to your business. For instance, research and development credits can be valuable for tech startups. Energy-efficient upgrades might qualify for other tax credits.

Not sure where to start when finding tax credits. There are resources available. For example, DSIRE is the most comprehensive source of information on incentives and policies that support renewable energy and energy efficiency in the United States. You can search their website for tax benefits that may apply to your business.

5. Maintain Compliance

Staying compliant is crucial for the long-term stability and success of your LLC. Non-compliance can lead to costly fines, legal issues, and damage to your business's reputation. But with so many regulations and deadlines to keep track of, how do you stay on top of it all?

At LLC Attorney, we understand that navigating the complexities of compliance can be challenging, which is why we’re here to help. We provide the tools and guidance you need to ensure your LLC remains in good standing year-round. Here’s how we can help you maintain compliance:

To maintain compliance:

1. Create a compliance calendar to track important deadlines
2. Stay informed about changes in regulations that affect your industry.
3. Consider designating a team member to oversee compliance
4. Regularly audit your business practices

For example, you may use a checklist that covers everything from employment laws to data security regulations. This proactive approach may help you avoid penalties and make it easier to secure contracts in highly regulated industries.

It's important to remember that compliance requirements can vary depending on your industry and location. A restaurant LLC needs to comply with health and safety regulations, while a financial services LLC must prioritize data privacy. With LLC Attorney by your side, you can navigate these complexities with confidence, ensuring your business is always on the right track.

It’s Time to Form Your LLC

Forming and running an LLC comes with challenges. But avoiding the most common mistakes and implementing these best practices can make a difference and put you on the right path. Start by tackling one area at a time. Then, review everything, from your income tax strategy to your business plan, on a regular basis.