Personal Liability Protection
One priority when starting your own business is protecting your personal assets from the debts incurred in business operations. Two legal business structures do not offer any such protection: a partnership and sole proprietorship. A common reason for operating a business as a partnership or sole proprietorship is the ease in forming these legal structures and the flexibility in management and operations, but each includes the risk of personal liability for business debts. Forming a corporation or an LLC involves some expense and more effort, but the advantage is personal liability protection from business debts. The additional benefit of forming an LLC is that state laws do not require the owners, known as members, of an LLC to follow the same formalities and rigid management structure required of corporations.
LLC Formation Filing Requirements
To form your business as an LLC in Washington State, you must comply with the Washington Limited Liability Company Act. The basic requirement is to file a document called a “certificate of formation” with secretary of state's office that contains the information listed in Revised Code of Washington Code 25.17.07. After the certificate is accepted for filing, your LLC comes into existence and is considered a separate legal entity. The LLC filing requirement is similar to the filing requirement to form a corporation, which requires filing articles of incorporation with the secretary of state. However, unlike a corporation, no further activity is required to form the LLC. For example, after incorporation, the business must hold a meeting to elect a board of directors and complete the organization of the corporation by appointing officers, such as the president, treasurer and secretary, and also adopting bylaws. There are no similar requirements to complete the organization of an LLC. Although Washington law allows LLC members to make agreements regarding the operation of the LLC, they are not required to do so.
LLC Management and Operating Options
A significant benefit of forming an LLC is that the management structure is very flexible. Members can agree to manage the LLC equally or appoint one member to be manager. If necessary, more than one member can be manager. The members can also hire a non-member as manager. For a small business, this can be a preferable management structure over the rigid structure of a corporation that requires both directors and officers. A further benefit over a corporation is that the LLC has flexibility regarding how it will be run. For example, an LLC is not required to hold periodic meetings or record formal minutes of each meeting like a corporation. Also, the LLC members can agree to allocate the profits and losses of the LLC among each other in any manner they see fit, regardless of a member's initial contribution to the LLC.
For federal income tax purpose, an LLC has the most options over other business structures. Because the IRS considers an LLC a "disregarded entity," you can opt for the LLC to be taxed as either a corporation or partnership, if there are two or more members, or as a sole proprietorship, if there is only one member. The LLC chooses tax treatment option by filing Form 8832 with the IRS. In general, the most advantageous tax option for an LLC is as a partnership or sole proprietorship. For these business structures, profits and losses pass through to the owners and there is no federal income tax paid by the businesses, thereby avoiding the "double taxation" problem of corporations. The problem arises when the corporation must pay federal income tax on its profits, which are taxed again when the profits are distributed to the shareholders as dividend. To avoid the double taxation problem, corporations can make a "Subchapter S Election," which results in receiving the same tax treatment as a partnership or sole proprietorship for federal income tax purposes. This approach can also be used to the benefit of a single-member LLC trying to avoid the self-employment tax problem. The sole member of a single-person LLC can choose corporation tax treatment for the LLC, and then elect to have the LLC taxed as an S corporation. The member is then paid as an employee of the LLC and not incur self-employment tax.
Washington State Business and Occupation Tax
Washington State does not have an income tax, but it does impose a gross receipts tax on all businesses, called the Business and Occupation Tax, or B&O tax. The tax rate is determined by the classification for you LLC's business. For example, a major classification such as wholesaling has a tax rate of .00484, unless a more specialized classification is available, such as wholesaling timber and wood products, which has a tax rate of .003424. Several credits are available under the B&O tax rules, one of which is for small businesses. This credit will vary depending on the total of all tax classification applicable to a business and other available tax credits. If you file your LLC's B&O tax electronically, the department of revenue will automatically calculate the small business tax credit.