Hans Kasper, MS-CPA, PS

How to Form an LLC
 

When you start a business in Washington and you want to incorporate it, you must determine the type of corporation you want to become.

You must determine why you would want to incorporate.  Please read the following: http://hkmscpa.forest.net/act%20like%20corp.htm.

I like LLCs because, if you follow the rules, you have personal liability protection and all anyone can get out of you is a charging order against the income of the business.  Many attorneys say that there is no difference, but, let me tell you that the protection of a charging order is significant when it comes to law suit time.  But, it must be set up correctly and you must follow the rules.

Generally, rather than a regular corporation, I recommend that you incorporate as a LLC (limited liability corporation.)

Many people (including attorneys) become confused about how LLCs are treated by the IRS; therefore, let me clear up the confusion.  The United States government, which began operating under the U.S. Constitution on March 4, 1789, was required to give to the individual states under the Tenth Amendment all rights not granted to the U.S. Government as stated in the constitution.   One of these rights is the right to license activities within each state—such as marriage, animals, autos, and businesses including corporations.  Therefore, when you incorporate your business, you are doing so at the state level.

However, under the Sixteenth Amendment to the constitution—the dreaded income tax amendment—that took effect in 1913, the federal government has the right to tax individuals and businesses.  Therefore, taxation of corporations at the federal level is a federal government right and is separate from a state’s right to license you. 

At the state level regarding licensing, there are generally two types of corporations: regular corporations and limited liability corporations.  At the federal level regarding taxation, there are two type of corporations: “C” corporations (regular) and “S” corporations.

A regular corporation at the state level can elect to be a “C” corporation or an “S” corporation at the federal level.  There is only one reason you would want to be a “C” corporation, you have large out of pocket medical costs that are not covered by a medical insurance plan, you have few or no full time employees, and the value of your business will never be much more than book value.  “C” corporations are detrimental because they are double taxed (not quite a pure double) at the time of sale or liquidation on any gain from the stock; “S” corporations are single taxed.  Generally, you will always want to be an “S” corporation; however, you should not be an “S” corporation if your sole business purpose is rental property or investments since there is a penalty tax in “S” corporations for passive activities—in this case you will want to be incorporated as an LLC and taxed either as a partnership or a sole proprietorship.

It is imperative that the original corporate minutes make an IRS Section 1244 stock election, which will allow up to a $100,000 loss deduction by the shareholders on their personal returns in case the business fails.

When the states came up with the LLC type of corporation several years ago, the federal government (IRS) did not know how to classify it within its taxation structure of individual vs. partnerships vs. “C” corporations, vs. “S” corporations.  Therefore, the IRS decided to let the LLC’s owners determine how they should be taxed at the federal level.  They created a Form 8832 Entity Classification Election for the LLC owners to make that election.  On that form, you can elect to be taxed as a corporation (box 2a), a partnership (box 2b), or a sole proprietorship—a disregarded entity (box 2c).  See more below.

To incorporate as a regular corporation in Washington, you can do so by going to http://www.secstate.wa.gov/corps/registration_forms.aspx and completing the application to form a FOR PROFIT corporation.  PLEASE NOTE THAT I REALLY, REALLY DO RECOMMEND USING AN ATTORNEY AND NOT DOING THIS YOURSELF.

To incorporate as an LLC in Washington, you can do so by going to http://www.secstate.wa.gov/corps/registration_forms.aspx and completing the application to form a LLC.  PLEASE NOTE THAT I REALLY, REALLY DO RECOMMEND USING AN ATTORNEY AND NOT DOING THIS YOURSELF.

Also, please read the following: http://hkmscpa.forest.net/act%20like%20corp.htm.

I also suggest that you obtain the following regular corporation materials for reference purposes:

http://www.nolo.com/lawstore/products/allCatProducts.cfm/catID/722D2CAE-5ED8-45CF-93B616C363735ECC

I also suggest that you obtain the following LLC materials for reference purposes: http://www.nolo.com/lawstore/products/allCatProducts.cfm/catID/957B8D73-7D06-48FC-997D47C1173D0843

Once you have completed the incorporation with the Secretary of State and receive back your Washington UBI# (uniform business identification number) for the corporation, then you MUST complete a Master Business Application at this web site:  http://www.dol.wa.gov/forms/700028.htm.  Please insert your UBI# on the MBA application or you will get two numbers.  If you are going to have employees, then you must complete this form correctly or you will have problems.  Also, if you want the owners of the business to be covered for labor and industries or unemployment, then they must complete a special form to elect INTO that coverage.

SUTA Form 5203 https://fortress.wa.gov/esd/portal/unemployment/taxes/notices/index_html/taxes/forms/voluntaryelection.pdf

L&I  Form F213-042-000 http://www.lni.wa.gov/forms/pdf/213042a0.pdf

Also, please read the following: http://hkmscpa.forest.net/master%20business%20license.htm

Also, please read the following: http://hkmscpa.forest.net/new%20business.htm

When you elect to be taxed as a corporation, a partnership, or a sole proprietorship that has employees then you must apply for an IRS employer identification number—Form SS4.  You can obtain your IRS employer identification number online by clicking on: https://sa2.www4.irs.gov/sa_vign/newFormSS4.do. It is important to fill out this form correctly or you will create a nightmare for yourself and pay me big bucks to fix it.

All LLCs must file Form 8832 with the IRS.  The Form and instructions are at: http://www.irs.gov/formspubs/lists/0,,id=97817,00.html.  If you want to be taxed as an “S” corporation, please see the next paragraph; otherwise, you will be taxed as a “C” corporation and you may not want to do so.  Corporations who are licensed with their state as a regular corporation do not have to file Form 8832.

Once you have completed Form 8832, if you want your LLC to be treated for IRS taxation purposes as a “S” corporation, then you must complete Form 2553 within 45 calendar days from the date of incorporation.  In Washington, which is a community property state, all spouses of owners must also sign this form.  Form 2553 and instructions can be located at : http://www.irs.gov/formspubs/lists/0,,id=97817,00.html.  It is important to correctly fill out this form or you will create a nightmare for yourself and pay me big bucks to fix it.

Notice dated 09/01/05: There are many people who think that by having an “S” corporation that they can pay less social security taxes than if they were a “C” corporation or a sole proprietorship.  If you are the sole owner of the business and the only employee, then this will not work.  It may have worked for years and it may work in the future that you can take less than 100% of your profit from the “S” corporation as a salary and save on those SS taxes.  However, the IRS has given its notice that they are going to come after these small “S” corporations for the SS taxes.  Therefore, if you want to be an “S” corporation and pay a diminished salary to yourself, then you should put three years of SS taxes plus penalties and interest in your savings account to pay the piper when he shows up.  In addition, the smaller your salary, the lower the amount you can put into your retirement account since the retirement percentage can be as high as 25% to 40% of your profits/salary in the “S” corporation.  In my opinion, that is how you cut your taxes.

Regular corporations who desire to be taxed as an “S” corporation also have to file Form 2553 with the IRS.

DOR = Washington Department of Revenue  http://dor.wa.gov/
MBA = Master Business Application 
ESD = Employment Security Department  http://fortress.wa.gov/esd/portal/
SUTA = State Unemployment Tax Act
L&I = Labor and Industries http://www.lni.wa.gov/

If your attorney does not prepare the documents marked in ORANGE, then you must let us know within 15 days from the date of incorporation and we will prepare these documents for you.