Starting an LLC, or a Limited Liability Company, sounds like a smart move – and it is. You get limited liability, tax flexibility, and a professional business structure. What’s not to love?
But here’s the catch: A huge number of business owners make critical mistakes when setting up their LLCs, leading to unnecessary expenses, legal troubles, and tax nightmares.
So, if you’re about to form an LLC, you’ll want to avoid these common pitfalls.
Thinking an Operating Agreement is Optional
Technically, some states don’t require an operating statement, but skipping it is still not ideal.
Imagine going on a road trip without a GPS. That’s what starting an LLC without an operating agreement is like. You’d only be setting yourself up for trouble.
An operating agreement includes:
- Who owns the business and what percentage.
- How decisions are made.
- What happens if a member leaves or if there’s a dispute between members.
Without a contract, disagreements can turn into expensive legal battles. For example, you and your friend decide to start an LLC. Everything’s fine until one of you wants out, and there’s no agreement on how to divide assets.
Now, you’re both stuck in a messy legal dispute.
Even single-member LLCs should have an operating agreement to clarify business procedures and strengthen liability protection.
Choosing the Wrong Business Structure
Just because an LLC is popular doesn’t mean it’s the right fit for everyone.
Some businesses benefit more from an S-Corp or C-Corp structure, especially when it comes to taxes and investor appeal.
For example, you’re a freelancer, and you start an LLC. Later, you realize an S-Corp would have saved you thousands in self-employment taxes.
This is why knowing both the pros and cons of an LLC is essential.
Some advantages of forming an LLC are:
- Limited liability protection
- Flexible taxation options
- Simple management structure
The catch?
- Some states have high LLC fees, like California.
- Self-employment tax can be costly if not structured properly.
If you’re unsure which business structure is best for you, speaking with a lawyer in your area can help. An LLC formation lawyer in Texas can prevent you from making the wrong choice now that can cost you thousands later.
Registering in the Wrong State
Some entrepreneurs get excited about the tax benefits of states like Wyoming, Delaware, or Nevada, but registering your LLC there isn’t always a smart move.
If your business operates in Texas but you register in Delaware, you’ll have to file as a foreign LLC in Texas anyway. This will double your fees and paperwork.
To avoid unnecessary complications, register your LLC where you actually do business. And if your business has clients in multiple states, consult an attorney to determine if you need to register in more than one location.
Mixing Business and Personal Finances
This is a huge mistake. The whole point of an LLC is to protect your personal assets, and if you mix business and personal finances, you lose that protection.
For example, as an LLC owner, you pay business expenses with your personal credit card. If you’re sued, a court will rule that your LLC isn’t separate from your personal finances, exposing your personal assets to liability.
What you can do to keep things separate is:
- Open a business bank account.
- Get an EIN (Employer Identification Number).
- Only use business funds for business expenses.
Ignoring Tax Obligations
LLCs are flexible with taxation, but this flexibility comes with responsibility.
Many business owners forget or miscalculate tax obligations, leading to costly penalties.
Some tax considerations for LLCs are:
- Single-member LLCs are taxed as sole proprietors by default.
- Multi-member LLCs are taxed as partnerships.
- You can elect to be taxed as an S-Corp for tax savings.
- Some states (like Texas) have no state income tax, but LLCs may owe franchise taxes.
Here’s a tip: If you’re making consistent profits, consider electing to be taxed as an S-Corp. This will reduce your self-employment tax burden.
Forgetting to File Compliance Reports
LLCs aren’t a “set it and forget it” deal. You need to keep up with annual reports, tax filings, and state compliance.
In most states, LLCs must file these two reports:
- Public Information Report (PIR)
- Franchise Tax Report
Skipping these can result in fines or even the dissolution of your LLC, meaning you’d lose your business name and legal protections.
To avoid this, set calendar reminders or hire a professional to handle compliance.
Assuming an LLC Shields You from Everything
An LLC protects personal assets from business debts, but it’s not a shield that can protect you from all liability.
You’ll still be personally liable if you:
- Sign personal guarantees on loans.
- Commit fraud or negligence.
- Fail to maintain proper business records.
The best thing to do is to get business insurance. Having liability insurance adds another layer of protection beyond what an LLC offers.
Overlooking Business Licenses and Permits
Forming an LLC doesn’t mean you’re legally allowed to operate. You might still need permits and licenses to actually do business.
For example, you open a new restaurant as an LLC but forget to get a health permit. Your restaurant will be shut down before it even opens.
Depending on your industry, you may need:
- Local business permits
- State licenses
- Federal licenses
Not Trademarking Your Business Name
Just because your LLC name is available in your state doesn’t mean someone else isn’t already using it.
A common misconception is that registering an LLC means trademarking your name. But the reality is that a registered LLC name only protects you in your state.
If you want nationwide protection, register a trademark with the US Patent and Trademark Office (USPTO).
Using a Home Address for Your Business
A lot of small business owners list their home address when forming an LLC, which sounds harmless enough. Until you realize:
- Your personal address becomes a public record.
- You get flooded with spam mails and sales calls.
- It looks unprofessional to clients.
The solution is to use a registered agent service to keep your personal information private.
Get Your LLC Right the First Time
Starting an LLC can be exciting, and avoiding these common mistakes will save you a lot of stress (and money). Every decision, from choosing the right structure to handling compliance properly, impacts your business’s future.
Don’t let simple mistakes jeopardize your business, and set up your LLC the right way.