Forming an LLC is the legal entity choice of many restaurant owners and for a good reason. This guide will tell you in simple language what you need to know about choosing an LLC business structure for your restaurant; the strengths and weaknesses, the steps to file for an LLC and how to make sure that an LLC is the best legal business structure for your restaurant. Whether a startup or sole proprietorship, if you're looking for increased liability protection before you decide to form a Limited Liability Company, get up to speed with this extensive and easy to understand guide.
What is an LLC?
An LLC is a limited liability company. If your restaurant is a sole proprietorship or partnership, the restaurant owners are personally responsible for any debts or liabilities incurred in the course of business. While this can be mitigated to some extent by having comprehensive business liability insurance, it does not provide the depth of protection that you can achieve by forming an LLC. Protection from liability is the primary reason for forming a limited liability company.
Why is an LLC considered the best business structure for a restaurant?
When you file for an LLC, it is the creation of a separate legal entity. Unlike a partnership or sole proprietor, the liability risk is absorbed by the LLC. It works as a firewall, keeping your personal assets out of reach from those who seek to collect on debts incurred by the business.
As a separate entity, your restaurant LLC can build it’s credit independently of your personal credit score. What that means is that even if you or your partners don’t have stellar credit, forming an LLC can potentially help you get business loans, when the LLC has a better credit score than you do.
Unlike a corporation, an LLC is much less formal. The requirements for corporations, such as having a board of directors, voting members, keeping minutes for meetings and the extensive filings required of corporations don’t apply to an LLC.
The cost of filing and compliance are far less than a corporation. Because an LLC is much simpler to form and there is less paperwork and fewer legal obligations, the cost of forming and maintaining an LLC is much more affordable than if you choose to incorporate your restaurant.
Flexible investment sources is another reason an LLC may be the best legal structure for restaurants. Unlike an S Corp, LLCs have no limit on foreign investment. Additionally, partners in an LLC can be corporations, other LLCs, trusts and there is no limit on the number of members participating in the LLC.
The IRS tends to look at sole proprietorships - especially ones with as much cash-handling as a restaurant - as a prime target for audits. The IRS assumes that there is likely some under-reporting of cash going on. While this may or may not be true, forming an LLC might relieve some of the undue attention the IRS gives to a sole proprietor performing a high number of cash transactions.
“The IRS tends to look at sole proprietorships - especially ones with as much cash-handling as a restaurant - as a prime target for audits.”
Who can form an LLC?
Most states allow a single member to form an LLC, and there is no restriction on the top end. An LLC can have an unlimited number of members. The members can be individuals, trusts, other LLCs, domestic corporations, foreign corporations, foreign individual investors and 501(c)(3) charitable organizations. In some states, the organizer for the LLC must be over 18, but there is no such restriction on LLC members. Although, this can potentially cause some legal complexities regarding contracts.
How are LLCs structured?
Before you file to form an LLC with the state, it’s important to structure the LLC and define the roles of the members.
Organizer - The organizer is the person who files for the LLC with the state by submitting the LLC’s Articles of Organization with the Secretary of State of the state that the LLC is formed in.
Registered Agent - The person who receives information intended for the LLC such as tax documents and notices. The registered agent can be a member or non-member, or a registered agent company. The only requirement is that you must have a registered agent in every state the LLC is registered to do business in.
Statement of authority - This document, once filed with the Secretary of State protects the members of an LLC by specifying which members are authorized to obligate the LLC to a third party. Without this, it’s possible for a single member of the LLC to represent the company, get loans or otherwise misrepresent the interests of the other members. To keep everyone on the same page, it’s highly advisable to file a statement of authority with the secretary of state, to protect other members of the LLC from any obligations created by unauthorized members.
If a member leaves the LLC, it’s important to update the filing. If you were an authorized member and you leave an LLC be sure to file a denial of authority! Otherwise, you can still be held liable or have your name used in association with the LLC.
There are two ways that an LLC can be managed. That is member managed and manager managed. In the context of an LLC “manage” means involvement in the day-to-day operations of the restaurant. It’s quite possible that not all the members want to be that involved and would rather function simply as investors.
In a member-managed LLC, all members are given a vote regarding operational decision-making. To move forward, the vote must be unanimous. You can imagine that in some cases, like where there are many members, this could be a burden.
A manager-managed LLC specifies some members or employees who are authorized managers. That is, they are given the authority to run the day-to-day operations of the company without having unanimous approval by the other members.
When choosing a management arrangement for your restaurant, consider the following examples, where one may choose one or the other.
A member managed arrangement is preferred when all members have industry or management experience and will be directly working with the public. Such as four friends who decide to start a burger-shop and work together as a crew, or who take shifts as managers overseeing employees.
A manager management arrangement is useful when some members don’t have management experience, or they will not be involved in decision-making at the management level. An example of this would be an investor with a busy day job who is friends with a chef, but he doesn’t know enough about the restaurant business or have time to be involved.
Operating Agreement - The founding document that explains the role of each member, their obligations and other mutually agreed contractual obligations of the partnership.
Additional items found in LLC operating agreements are things like how members are added and removed, how profits are distributed and how assets would be distributed if the LLC is dissolved.
In a member-managed LLC, the operating agreement an also be used to take some of the decision-making pressure off of some members, without having the additional complexity of organizing a manager-managed LLC. The operating agreement can specify members authorized to take unilateral actions on behalf of the LLC. For example, if one member of a restaurant business is a chef and the other members are not experienced in menu engineering or hiring kitchen staff, it might make sense to give this member unilateral power in these areas.
When it comes time to make a decision about the company, all members must be in agreement. That doesn’t mean they all vote the same way, but it does mean that there is no dispute regarding the result. To achieve this, it’s important that voting rights and the system of weighing votes is spelled out in the LLC’s operating agreement.
Informal Voting - Remember, LLCs are informal by nature, and that’s part of the appeal. When it’s “not a big deal” a formal vote is not required. This would be decisions made in the daily operation of the restaurant business. For example, getting approval for a new list of ice cream flavors by CC-ing members in an email.
Formal Voting - Sometimes it is a big deal, and everyone needs to weigh in on the decision before moving forward. In these cases, there are two ways that a member’s vote can be weighed. This should be clear in the operating agreement.
- Per Capita - One vote per person. It’s a straight majority vote.
- Interest Percentage - Each member’s vote weighs as much as their percent stake in the business.
How to form a Restaurant LLC
Once you have chosen a state to file in, the next step is to write up the operating agreement. This can be a simple or complicated process depending on the number of members and how power and duties within the organization are distributed. This is the contract between members and tells the state how the LLC is legally structured. It gives you additional protections from liability by specifying member roles and financial responsibilities. Many states don’t require an operating agreement at all. Regardless, care should be taken in this step to craft a suitable agreement between the restaurant’s founding members.
When crafting an operating agreement, consider future legal issues and strive to clarify the internal organizational structure of your LLC head of time.
One of the most important things to document in the operating agreement is what each member has contributed regarding assets, services and the size of their ownership stake. The members together decide how to compensate each other for their contributions.
In addition to ownership percentages, LLC members have a share in the profits or losses that the company takes; this is called a “distributive share.” Come income tax time; the LLC passes its tax burden through to the individual owners. It’s important to take this into account when writing the Operating Agreement. It’s not a given that profits will be taken out of the company every year. However, members of the LLC are required to personally pay income taxes proportional to their ownership percentage of the restaurant. The how, when and how much of the profits each member should expect to have distributed to them should be spelled out.
Also be sure to include the following information in your restaurant’s operating agreement:
- What voting powers members have
- How profit and loss are distributed to members
- Each member’s stake in the restaurant
- Rules for meetings and taking votes
- Unilateral actions permitted by members
- The specific management structure and hierarchy
- Member’s rights and responsibilities
Also, cover eventualities like what happens if one of the members dies or becomes otherwise unable to fulfill their obligations.
Articles of Organization
This is the document filed with the state to officially form your LLC. Most states require this document to be filed with the Secretary of State in the state you’re forming the restaurant LLC in. Some states even have pre-built forms you can simply fill out.
The information included in the articles of organization vary between states, but the basic requirements are
- Company name
- Address where you are doing business
- Name and address of the registered agent
- A statement about the management and organizational structure of the LLC
- The purpose of the LLC
- The duration of the LLC
- Signature(s) of members authorized to form the LLC
“When crafting an operating agreement, consider future legal issues and strive to clarify the internal organizational structure of your LLC head of time.”
State Requirements for LLCs
Since laws regarding limited liability companies are established through the state legislature, there is some variance between the laws regarding LLCs from one state to the next. Another aspect of this deviation is the way the state taxes an LLC.
However, there are some steps you can count on to be the same or very close in most states, and we’ll go over those steps here.
File Articles of Organization with the Secretary of State
When filing the articles of organization, the name of the company should have “LLC” at the end, or the state will add it. It also must be a unique name or the application will be rejected.
Choose a Registered Agent
A registered agent must be designated. This is the person who will receive information and notices directed to the LLC. List the name and address for people to contact. This can be a member of the LLC another individual who’s not a member or an authorized registered agent service.
Statement of Purpose
The statement of purpose is a short description of why you are forming the LLC and what you plan to do as a business. It can be a mission statement or very general like, “To perform all legal acts permitted by limited liability companies.”
Indicate if the LLC is going to be manager managed. If you don’t the default is member managed. If you don’t want the restaurant’s legal entity to be member-managed, it’s important to specify manager-managed when forming with the state. You may be required to supply the names and addresses of your managers as well.
Principal Place of Business
This is pretty straightforward. If you only have one restaurant location, it will be the address you’re operating out of. If you have multiple locations, you will list the address that you manage the sites from.
Specify who in the organization is authorized to sign papers on behalf of the restaurant business. This is important to designate because by default any member could assume this role and obligate the other members. However, if the intent is for all members to have an equal partnership, such as in the case of a member-managed LLC, having all members sign shows solidarity of intent.
Most states ask for the LLC’s intended duration, and some have an indefinite duration that would dissolve the LLC if one of the members leaves or dies. However, by defining the LLC as perpetual, you can make it clear that the intent is not to dissolve the LLC after a period or given event. If the LLC is going to dissolve you can file for an LLC life extension.
Some state differences
If you form your LLC in a state that doesn’t publicly release the identities of the LLC members, this is considered an “anonymous LLC.” Although it is no different than a regular LLC, it’s worth noting that some states don’t publish membership details if you’re concerned about privacy.
You can form an LLC in any state you choose. However, if it’s not your home state, then you’ll also need to obey the tax laws, fees and regulations for both the state you file in and the one you're doing business in.
Some states require that individuals who are members of an LLC must be over 18 years old.
Links to state government Secretaries of State: http://www.coordinatedlegal.com/SecretaryOfState.html
Costs of Forming an LLC
State Filing Costs
The fees vary greatly from state to state, from $40 to almost $600. Most states are somewhere in the middle of the extremes. To get the exact rate, check the secretary of state’s website for the state you are forming in.
You may need the state to send you certified copies of your documents once approved, for your taxes. There are additional fees for this.
If there is a problem with your name or something else that causes a rejection, you’ll be subject to additional re-filing fees.
Trademark or Copyright
Your restaurant isn’t going to be named “ABC American Restaurant LLC” so you’ll need to consider the fees for creating a trademark, or name mark to register at the state or federal level. This is an additional cost.
Franchise tax or license fees are charged by many states and like the initial filing fees, vary greatly from $80 to $800. You must pay these fees every year to stay in good standing and maintain the liability protection the LLC provides.
It’s an archaic practice, but some states require that you publish a notice of LLC formation in a local newspaper approved by the county clerk’s office. It may have to run for months, and the fees charged by the newspapers can be quite high. Some are over $1,000, but the cost will be unclear until you contact the paper.
In states you operate in but are not located in you’ll need to pay a registered agent to maintain your presence in that state. Fees are around $100 a year.
Simple online assistance starts around $50 and goes up from there depending on how much assistance you require. However, this can be a valuable service if it means ensuring that you don’t have to re-file.
Attorney fees for more complicated filings are as you would expect, more costly. If you have a more complicated arrangement between members, the ownership agreement is complicated or its manager-managed, it may be a good idea to have an LLC attorney help with the formation.
LLCs and Federal Taxes
LLCs are filed with state governments and are not technically acknowledged by the IRS. They use the term “disregarded entity.” For tax purposes, you have some options when it comes to how you and the other members of your restaurant company want to file.
Filling as a Sole Proprietor / Partnership
The LLC functions as a “pass through” for tax purposes. If it is a single member LLC, the IRS views it at a sole proprietorship for tax purposes. Multi-member LLCs are taxed as partnerships. Member’s share of the profits (or losses) of the company is taxed at their individual tax rate. This can prove frustrating since the so-called profits of the business may not necessarily be distributed to the members. Businesses with often retain profits to invest back into operations, to secure their financial or to grow. Regardless of payout, the IRS will expect you to personally pay taxes on the profit created by the restaurant.
“Businesses with often retain profits to invest back into operations, to secure their financial or to grow. Regardless of payout, the IRS will expect you to personally pay taxes on the profit created by the restaurant.”
Filing as an S Corp
If you’d like to file as an S Corp, the IRS will allow you to do so. An S Corp is still a pass-through entity, and members are taxed based on how many “shares” in the company they own. The benefit comes from the difference between how employment taxes are handled. When you are taxed as a sole proprietor, you have to pay 100% of the employment tax, also called the self-employment tax. Filing as an S Corp drops that obligation to half personal obligation and half paid by the business.
To file as an S Corp, file an election document with the IRS, then file Form 1120S to report profits, losses, deductions, and credits for the year. A Form K-1 is given to each member with details of their share of ownership of the assets and liabilities reported on form 1120S. The members are referred to as shareholders for tax purposes because the LLC is now regarded by the IRS as a corporation. They file a Schedule E form with their 1040 personal tax return.
Another benefit of being viewed as an S Corp for tax purposes is that when members do take profits out of the company, some of it can be as a distribution. A distribution is not subject to employment taxes.
There are some restrictions however. There can’t be any foreign investors in the LLC, and all the partners must be individual people, not other legal entities such as LLCs, corporations or partnerships.
“If the members plan to retain a significant portion of the LLC’s profits in the company rather than paying it out, it may make sense to file taxes as a C Corp (corporation) instead.”
Filing as a Corporation
If the members plan to retain a significant portion of the LLC’s profits in the company rather than paying it out, it may make sense to file taxes as a C Corp (corporation) instead. In this form, the LLC is responsible for paying taxes, and it is no longer a “pass through.” Taxes are paid at the appropriate corporate tax rate, and members are taxed only on their wages received. There is no self-employment tax, as the corporation pays its half of the employment tax.
To move forward with this, the members must vote and file IRS Form 8832. Once the form is filed, however, it’s only retroactive 75 days before filling. If the tax period already started before that, you’ll need to file taxes as a partnership for the period up to to the Form 8832 taking effect.
You will need to file Form 1120 with the IRS and your day to file may change under corporate tax regulations. The 15th day of the third month following the close of the tax year. Also, a quarterly employer tax return, IRS Form 941 is required as well.
Keep in mind that being taxed as a corporation makes double taxation occur. Once when the company is taxed, and again when distributions appear on the personal income taxes of the members. You and the other restaurant members will want to carefully weigh the costs and the benefits of this arrangement.