You’ve come up with a great business idea, made a plan, and know who your customers are. Maybe you’ve even started working already alone as a sole proprietor or in a partnership with your co-founder. While that is great, if you’re here, you’ve probably read about why you need to look into starting a company and lowering your personal liability protection. Operating a sole proprietorship or a partnership can be risky, as business owners can be held personally liable for any debt the business encounters. By forming a company, these liabilities are minimized, but as a result, management is faced with many formalities that can be limiting.
You’re a keen entrepreneur who is doing research on all your options, so you’ve likely seen that a popular choice among new, small businesses is to start an LLC, or limited liability company. Whereas anybody can start an LLC, only licensed professionals by the state licensing board can form a PLLC, or a professional limited liability company.
We’re going to go through what makes an LLC an LLC, and point out in each section what the main differences are that set them apart from their cousin, the PLLC. This guide is only here to provide an overview for you, but you should always consult a legal expert when making big business decisions like this, especially since regulations, state laws, and licensing requirements vary from state to state, and even county to county.
Who Can Open a PLLC vs LLC?
There are restrictions on membership and the limitations offered in terms of liability. Whereas anybody can be a member (member refers to an owner) of an LLC, only professional license individuals can be members of a PLLC, or conversely, there must be at least a certain number of professionals among the members. To clarify, the members of a PLLC must be of the same profession. That is, you cannot commingle the professionals identified below in one PLLC and offer a variety of services. Some of the professionals who would benefit from opening up a PLLC include:
It’s also important to mention that if you live in California, professionals are prohibited from starting either LLCs or PLLCs. You must instead create a professional corporation or an LLP, limited liability partnership.
What is an LLC?
The limited liability company is a hybrid business structure somewhere in between a sole proprietorship or partnership and a full blown corporation. It could be argued that it offers the best of both worlds: the tax flexibility of sole proprietorship and the asset protection offered by corporations.
One of the main reasons the LLC structure is so popular among small business owners is that it provides tax flexibility. A single member LLC will be taxed as a sole proprietorship and a multi member LLC will be taxed like a partnership by default. This means, the profits “pass through” to the company’s members and they pay taxes on their personal income tax forms. Corporations, classed as C-Corps, however, have the burden of double taxation to deal with. This means the entity pays taxes on its corporate profits and then the individual employees also pay taxes on their income.
In order to get around this double taxation burden on small business, Congress established a special kind of corporate tax classification, the S-Corp. These corporations are able to apply the same “pass through” taxation, while being fully incorporated.
LLCs have the option of filing as an S Corporation or C Corporation, rather than their default sole proprietorship or partnership tax classification.
Liability protection is the key aspect of LLCs and a major reason why sole proprietorships and partnerships choose to convert their entity structure. It separates you, the owner or member, from the company. Whatever debts or suits fall upon the business, by and large, your personal assets—bank account, house, or vehicle—will not be in jeopardy should the business be unable to pay.
This means that individual members will not be liable for any debts or judgments that the business might incur unless a court determines the necessity of piercing the corporate veil, in which case you should consult with your attorney. Because of this, banks will sometimes require a personal guarantee before they make the decision to give a loan to an LLC or PLLC. That way, if the business entity defaults on the loan, there will still be someone financially responsible for paying the debt.
Also, members in a PLLC are not protected from malpractice claims, but other members are not liable for the malpractice claim of another individual of the PLLC, so you may want to look into obtaining or reviewing your own malpractice insurance.
Setting up your LLC or PLLC
One of the main advantages of starting an LLC instead of a corporation is that it’s a lot simpler. There are fewer forms and regulations at the start, and there aren’t too many filings required annually with the state. The paperwork can get to be a bit much with corporations, on the other hand.
The first thing you need to do is to choose a business name. If you go with the regular LLC, your name must be unique to the state you’re opening shop in. You also need to avoid any terms that are similar to government agencies or that make it seem like you’re a professional service. You likely also need to append LLC, Ltd. Or Co. to the end. See, e.g., Cal. Corp. Code § 17701.08; Del. C. § 18-102; NRS 86.171; Tex. Bus. Code § 5.056; W.S. 17-29-108. These rules vary from state to state, so make sure you are aware of your local regulations.
If you are a professional service, then the PLLC might have more requirements. Commonly, you’ll need to include “Professional Limited Liability Company” or PLLC at the end. Again, this will depend on your state.
Choose a registered agent. This is the same for LLCs and professional LLC. You need to find an individual or company who will be the contact person between the state and your company. They will file the necessary paperwork and will receive any legal or government communication pertaining to your business formation. Typically, they are required to be residents of the state in which you operate.
File your Articles of Incorporation. Once you have your unique name and agent, you enter this information along with your address. Once this is filed with your state’s Secretary of State your LLC will officially be formed.
For a PLLC, you will likely also need to file the Articles with your profession’s governing body as well, in addition to verifying your licensing status. They will generally need to approve before you file with the state. They will need to verify that each member of your PLLC is certified to practice. The specifics of this process vary by state and there are particularities depending on your profession.
Obtain an EIN. You need your Federal Tax ID number for many things: hiring employees, paying taxes, and filing various licenses and forms. This is like your company’s Social Security number and will serve as an identification number that your staff will use on a regular basis.
Draft an Operating Agreement. While this is not required in most states by law, it is highly recommended that you draft an Operating Agreement before you open your doors. This document serves as the codified rules and regulations of how your company will operate day-to-day, who will be a member, and how decisions will be made. It serves as a legally binding document that will put all LLC members on the same page and prevent many disputes later on.
Operating Agreements serve as an LLC’s bylaws and usually cover the following topics:
How the business will be taxed
Statement of purpose
Number of members
Even in the few states that do require LLCs and PLLCs to have an Operating Agreement, there are no specifications with what should be included or whether it must be in writing. Rather, state laws usually outline what you cannot alter or include in your entity’s Operating Agreement. Therefore, it’s highly advisable to consult a legal professional when drafting your Agreement to ensure you cover all your bases and minimize your risk down the road with regard to potential disputes.
If you’re starting a solo practice and opening up an LLC or PLLC of one, you might think it’s a bit silly to write a whole document detailing the procedures for yourself. However, consider that in a year or two, you may grow your workload and need to hire on someone new or even bring in a partner. In this case, you will be glad to have a document that spells out how you want everything conducted in detail.
Further, an Operating Agreement will lend your LLC legal credibility. Having this document will legitimize your new business in the eyes of the law, should you ever have to go to court. Oftentimes, banks will also request a copy of your Articles to review before allowing you to open an account or take out a loan.
Although starting a business requires going through a great deal of red tape and specific documentation, determining whether your business will be a limited liability company or a professional limited liability company is one of the easier tasks. Once you have done the research for your state and profession and taken the appropriate steps, getting your respective state’s licensing board’s approval should be easy. Make sure to inquire into specifics and check with your licensing agency for help. Every state has its own unique laws regarding LLCs and PLLCs, so it is crucial that you fulfill the requirements for your respective state and profession.