Choosing a form of business entity is not the matter of a moment for an entrepreneur. The decision will have a big impact on many different aspects of managing and running a business. The choice of business structure, whether sole proprietorship, limited liability company, corporation or something else, will impact taxes paid and personal liability, as well as the type of regulation the business will face.
In Iowa, as in most states, forming a limited liability company (LLC) is one of the most common ways people choose to structure their business. This choice has both advantages and disadvantages.
What Is an LLC?
A limited liability company is a business structure authorized under the Iowa codes. Think of it as a hybrid that combines the characteristics of a corporation with those of a partnership or sole proprietorship.
Since every state is free to regulate LLCs, don't expect Iowa's laws to mimic those of other states. Generally, formation of an LLC gives the owners of the business – called members under Iowa state law – protection against personal liability for business debts. That means that they are not on the hook personally for the debts and obligations of the company. In this way, the business form resembles a corporate structure.
In addition to this liability protection, LLCs are popular for two other major advantages: the ease and rapidity of set-up and federal tax treatment.
Understand Iowa LLC Membership
Iowa law, like laws in most states, does not restrict LLC ownership to individuals. Members of an LLC can be individuals, corporations, other LLCs or even foreign entities. A single-member LLC is legal in Iowa, but the maximum number of members of an LLC is unlimited. It may come as a surprise to learn that major companies like Alphabet, the parent company of Google, Exxon Mobil Corp., and Johnson & Johnson are all formed as LLCs, though not in Iowa.
The laws exclude a handful of types of businesses from potential LLC membership. These include banks and insurance companies. Note that different rules apply to foreign LLCs that are registered in another country than apply to domestic LLCs registered in the United States.
Advantages of an LLC
An LLC is quick and easy to set up. This business structure involves fewer formalities and less paperwork than setting up a corporation. Setting up an LLC doesn't take a lot of time or money.
There are three big advantages to using an LLC as a business structure:
- Limited liability protection.
- Pass-through federal taxation.
- Ease of setup.
Limited Individual Liability
While there are a number of significant advantages to selecting a limited liability company as a business form, perhaps the most important is the limited liability protection. Limited liability protections are attractive because business creditors generally cannot sue LLC members if the LLC lacks assets to pay its business debts.
The limited liability company's structure is similar to a corporation, protecting the LLC owners from being personally pursued for LLC obligations. It also insulates the partners and/or investors of the LLC from individual liability.
Iowa Business Owners Enjoy Pass-through Taxation
A second major advantage to the formation of a limited liability company is the relatively simple tax treatment of LLC profits. In Iowa, it is not necessary for the LLC member to file a separate business tax return for the LLC, which saves members both time and money.
This is called "pass-through" taxation. The profits of the LLC business are divided among the membership interests. The members pay taxes on their share of the profits on an individual level. Pass-through taxation gives the LLC business form an extremely efficient method of dealing with tax liability.
Benefit From Easy LLC Formation
The third major advantage to using an Iowa limited liability company as a business form is the ease of setup. The exact requirements for LLCs vary by state, but Iowa makes it as easy as possible by creating a Fast Track Filing online portal. However, those who prefer to mail their registration documents or fax them can do so.
The steps in registering an LLC with the Iowa Secretary of State include:
- Select a company name.
- File articles of organization with the state.
- Pay a fee to the state for registration.
- Obtain an employer identification number (EIN) from the Internal Revenue Service (IRS).
Select an LLC Name
Selecting a business name is a bit more difficult than it sounds, since Iowa imposes certain name restrictions. Essentially, the name must be distinguishable from the names of other LLCs, as well as individuals and other businesses. It must also include the term "limited liability company" or an accepted abbreviation of that term, such as LLC.
File Articles of Organization
The Iowa state LLC laws set out guidelines for creating an LLC operating agreement. This agreement establishes the right and obligations of every LLC member, as well as their powers and duties. In Iowa, the operating agreement must also include the names and addresses of all of the LLC's members, identify the LLC's registered agent, and set out the business' statement of purpose.
This operating agreement should also create rules for how the particular LLC is to operate. The rules set out in the operating agreement, called “terms” or “provisions,” cannot override state laws on LLC rights and responsibilities. However, they can and must cover standard provisions like:
- Defining the responsibilities of a member.
- Describing if and how new members may be admitted.
- Describing how members can sell, transfer or end their membership.
- Describing the distribution of profits and dividends.
- Setting out the procedure required to change the operating agreement.
Pay Iowa LLC Filing Fees
Iowa charges a filing fee for accepting the LLC operating agreement. This fee is among the lowest in the nation at $50. Some states charge up to 10 times that much for creating an LLC.
After the creation of the LLC, Iowa requires the filing of an Iowa LLC biennial report between January 1 and April 1 of every odd-numbered year, beginning after the first calendar year of the LLC’s effective date. The state fee for filing the biennial reports are $45 if done online and $60 if done by mail.
Understanding LLC Disadvantages
No business structure that has advantages comes without disadvantages. The major disadvantage to consider with an Iowa LLC is that the LLC form of business makes attracting investment capital more difficult.
Corporate owners and managers can get new investment capital by issuing and selling more stock, but an LLC doesn't issue stock. While the members can vote to allow new members into the LLC, this is a longer and more awkward process.
In addition, the costs of creating and managing an LLC, however small, are larger than the costs of forming a sole proprietorship or a partnership. Neither one of these business forms are required to pay to file biennial reports.
Finally, the direct taxation of business profits, while certainly easier, may not work well for all businesses. Corporations often hold back profits for reinvestment, but LLCs do not have that option. If the LLC is extremely successful, its members may find themselves assigned more profits than they thought possible, resulting in paying extremely high individual taxes.
LLC vs. Sole Proprietorship
It's easier to understand an LLC and its benefits and disadvantages with a clear understanding of the distinctions between the LLC and other business forms. Let's start with the sole proprietorship.
A professional person like an attorney may choose to operate as a sole proprietorship rather than an LLC. When they do so, they accept personal liability for any debts of the business.
For example, if a sole proprietor law firm leases office space, then abandons it for lack of clients, the attorney is personally responsible for this debt. If they opt to end the law firm, the landlord can sue the attorney personally for the lease payments. This is also true if the attorney's sole proprietorship loses a big malpractice case. As an LLC, this is not the case.
LLC vs. Partnership
What about a partnership? The biggest difference between a partnership and an LLC is the same: the LLC separates the business assets and debts of the company from the personal assets of the members. Two attorneys who opened a law firm as a partnership would both be liable for the office lease payments, but as LLC members, they would be insulated from the business' debts and liabilities.
LCC vs. Corporations
Both LCCs and corporations protect the owners of the company from personal liability. However, ownership of each is very different.
The main distinction between an LLC and a corporation is the difference between members and shareholders. An LLC is owned by its members, each of whom is an owner with a voting interest. The person setting up the LLC can select those they wish to be members and limit transfer of shares.
On the other hand, a corporation is owned by its shareholders. In a publicly traded corporation, anyone who buys a single share of the corporation is one of the shareholders. This makes corporate meetings and notification requirements much more complicated. And a corporation can obtain investment capital by issuing and selling new shares.
This leads to a difference in taxation. Iowa and the federal government treat an LLC as a pass-through tax entity. Business profits are passed through the LLC to the members, with profits and losses reported on the individual member level, not the business level.
Taxation of LLCs
Losses or operating costs of an LLC are deducted on members' personal tax returns to help offset other income. The rate depends on a particular member's income, so the same profit share can result in different tax rates.
On the other hand, corporations are taxed as separate legal entities. The business is responsible for paying corporate tax on its profits. Dividends are double-taxed, by the corporation when earned and by the shareholder when distributed.
However, this double taxation disadvantage can be offset by federal corporate deductions like 100 percent of business expenses. These deductible expenses include advertising costs, operating expenses and employee fringe benefits, like medical and retirement plans. Expense deductions reduce corporate income and can offer important savings for the business over time.
When a corporation has fewer than 100 shareholders, it can file as an S Corporation resulting in pass-through taxation like an LLC. An S Corporation might be a valid option for a business that needs pass-through taxation along with some of the benefits a corporation provides.
Teo Spengler earned a J.D. from U.C. Berkeley's Boalt Hall. As an Assistant Attorney General in Juneau, she practiced before the Alaska Supreme Court and the U.S. Supreme Court before opening a plaintiff's personal injury practice in San Francisco. She holds both an M.A. and an M.F.A in creative writing and enjoys writing legal blogs and articles. Her work has appeared in numerous online publications including USA Today, Legal Zoom, eHow Business, Livestrong, SF Gate, Go Banking Rates, Arizona Central, Houston Chronicle, Navy Federal Credit Union, Pearson, Quicken.com, TurboTax.com, and numerous attorney websites. Spengler splits her time between the French Basque Country and Northern California.