If you are starting or already operate a crypto business, you may be wondering if you should form an LLC. Setting up a crypto LLC can be a smart move, especially if you’re serious about protecting your personal assets and managing your taxes more effectively.
The growing importance of cryptocurrencies
In recent years, cryptocurrencies have emerged as a transformative force in the global financial landscape. Initially viewed with skepticism, these digital assets have gained significant traction and are now recognized for their potential to revolutionize various industries. Cryptocurrencies offer a decentralized alternative to traditional financial systems, reducing transaction costs and enhancing security and transparency. This decentralization makes financial services more accessible to a broader population and has fueled their adoption.
What is an LLC?
A limited liability company (LLC) is a type of business structure that is recognized by law as a distinct entity separate from its owners.
A key benefit of forming an LLC for your crypto business is that it provides the business owners (known as members) with limited liability protection. When you form an LLC, your personal assets are shielded from business debts and lawsuits.
Anyone can be an LLC member, including yourself, other individuals, corporations, other LLCs, and foreign entities. In most states, an LLC can be formed for any purpose. However, in some states certain entities, such as banks or insurance companies, cannot be operated as an LLC.
For more information, read our guide on LLCs.
Reasons for forming a crypto LLC
There are many benefits to forming an LLC if you are a crypto investor or operate in the crypto space.
Liability protection: Holding digital assets in a legal entity like an LLC can protect your personal assets from legal or financial risks. An LLC keeps your personal assets separate from business debts and liabilities, offering a layer of protection against financial claims.
If you have multiple business partners, an LLC with a clear, written operating agreement can protect each partner's share.
A crypto LLC must keep separate records and books to maintain this protection. This helps avoid situations where the difference between the individual and the business is lost because assets are mixed together.
Tax optimization: An LLC can reduce its tax burden in several ways, primarily by lowering the owner's taxable income. For example, an LLC can deduct legitimate business expenses, such as equipment, office supplies, or travel, which reduces your company’s net income and, in turn, the amount of tax owed.
Anonymity: Creating an LLC for cryptocurrency can offer some level of privacy for your digital asset transactions. With an LLC, you can manage transactions under the business name instead of your personal name. Keep in mind that in some states, the members (owners) of the LLC are listed on the formation documents and anyone can request a copy of the formation document from the state.
There may be an option to form an anonymous LLC, which can help you keep your identity private. This can be done by using nominee services or hiring a third-party representative to file the documents on your behalf. However, not all states allow anonymous LLCs, and the rules differ depending on where you register.
Investment restructuring: Setting up an LLC for investing is a smart way to bring together a group of investors. It provides liability protection and tax benefits. A crypto LLC can be used to pool capital, manage digital assets, and invest in tokenized assets or decentralized finance (DeFi) protocols.
Credibility: Having "LLC" in your business name helps your business to appear more credible to the government, other business owners, and customers. This official status shows that you're serious about your business. It also helps you get business bank accounts, credit cards, and loans more easily, which you may need to grow your business.
Estate planning: Creating an LLC for cryptocurrency investments can make passing on your digital wealth easier. An LLC can help you manage your estate and to pass your assets to your family. By using an LLC, you can lower the value of your estate. You can give shares of the LLC to family members in a way that controls how they are shared and reduces the estate tax you might owe.
Limitations of a crypto LLC
Despite the many benefits of forming an LLC for your crypto business, there are potential disadvantages:
Maintenance: An LLC, like an S or C corporation, has ongoing compliance responsibilities. These include state obligations, such as having a registered agent and filing an annual report. It's also important to keep clear and separate records. Similar to what corporations must do, they need to keep financial records for the business and the owners distinct from each other.
Cost: Creating and maintaining an LLC costs more than a sole proprietorship or general partnership. An LLC usually requires a formation fee and other ongoing fees, which vary by state. In contrast, sole proprietorships and general partnerships generally don't require registration or associated costs.
Investors: Many investors prefer corporations. Corporations typically provide more protection for shareholders. Investors who don’t want the business’ income reported on their personal income tax return prefer to invest in C corporations. Corporations are also better suited for going public (IPO). However, most small business owners may not need to worry about these factors when starting off.
Steps to setting up an LLC
The steps and requirements for forming an LLC vary by state:
Step 1: Choose a name for your crypto LLC
To form an LLC, the name must contain words or abbreviations that indicate what kind of business entity it is, such as "Limited Liability Company" or "LLC." States also have rules about certain words that you cannot use and require that the name be distinguishable on the records of the state from any other business entity.
Step 2: Determine management structure
LLCs can be managed in two ways:
- Member-managed: All members take part in the daily operations of the LLC. A “member” refers to the owner of the LLC.
- Manager-managed: One or more managers are chosen to make decisions for the LLC. A “manager” can be a member or someone who is not a member of the LLC.
Step 3: Select a registered agent
A registered agent is an individual or business entity (which can be a service provider) you appoint to receive important documents for your LLC and forward them to you or someone else (such as your attorney) according to your instructions. This includes legal papers. The registered agent must have a physical address in the state and comply with other state requirements.
Step 4: Create an LLC operating agreement
An LLC operating agreement outlines and controls how the LLC is structured and operates and how the rights and obligations of the members and managers, if any will be shared. Without an operating agreement, an LLC is subject to the state’s default rules. Although in most states an operating agreement doesn’t have to be in writing, a written operating agreement is recommended to avoid the misunderstandings that can happen with oral agreements.
Step 5: Prepare and file Articles of Organization
To officially create an LLC, you must file Articles of Organization with the business entity filing office (such as the Secretary of State) in the state in which you form your LLC. The formation document is called something different than Articles of Organization in some states.
Step 6: Obtain an EIN
A federal employer identification number, or EIN, is a unique nine-digit number the IRS gives to identify a business for tax reporting. Also known as a FEIN or federal tax ID number. To obtain an EIN you apply for one with the IRS.
Step 7: Open a business bank account
To keep your limited liability protection and the benefits of your LLC, it's important to separate your personal assets and transactions from those of the LLC.
Step 8: Meet license, permit, and registration requirements
Your crypto LLC may need to meet specific license, permit, and/or registration requirements. These do vary by state as well as local jurisdiction.
Conclusion
Forming an LLC for your crypto business can provide significant advantages, including personal asset protection, tax optimization, and enhanced credibility. It offers a structured approach to managing your digital assets while limiting personal liability. However, it’s essential to weigh these benefits against the potential drawbacks, such as ongoing maintenance costs and complexities in attracting investors.
Ultimately, whether you form an LLC depends on your specific business needs, goals, and growth plans.
Crypto LLC FAQs
Can an LLC buy and/or own crypto?
An LLC can buy and own digital assets like cryptocurrency and non-fungible tokens (NFTs).
How are crypto LLCs taxed?
LLCs do not pay federal income taxes on their earnings. Instead, the income goes directly to the individual members of the LLC. Each member then reports this income on their personal tax returns and pays federal income tax based on their earnings from the LLC. This is known as “pass through” taxation.
If an LLC has one owner, it is treated as a "disregarded entity" for tax purposes. This means the IRS does not consider the LLC as separate from its owner. The owner reports the LLC’s income and expenses directly on their personal federal income tax return.
If an LLC has two or more owners, it is considered a partnership for federal income tax purposes.
Pass-through taxation is the “default” way an LLC is taxed, meaning that if the LLC does nothing, it will be taxed like a sole proprietorship or partnership. However, an LLC also has the option of being taxed as a C corporation or an S corporation. It does so by filing the proper forms with the IRS.
Note: Members of an LLC are considered self-employed. This means that FICA taxes, which cover Social Security and Medicare, are not taken out of your paycheck. Instead, you pay these taxes directly to the IRS. This is called the self-employment tax. Some members choose to have their LLCs taxed like an S corporation because it can help lower their self-employment taxes.
How are cryptocurrencies taxed?
According to Notice 2014-21, the IRS sees cryptocurrencies as "property" instead of currency. This means they are taxed similarly to traditional investments like stocks. If you sell cryptocurrency for a profit, you must pay capital gains tax.
If you sell it for a loss, you might be able to deduct that loss. However, cryptocurrencies have some additional tax rules that you should know about. It's important to talk to a tax professional to understand the tax implications for you and your LLC.
Should I form my crypto LLC in Wyoming?
Wyoming has become friendly towards Bitcoin and cryptocurrency over the past decade. The state has a business-friendly tax system with no corporate or personal income tax and no franchise tax.
Wyoming LLCs enjoy strong privacy protections. The names of LLC owners do not need to be listed on the Articles of Organization, which means they won't appear in public records. However, if someone sues your business, they can still access bank records, property deeds, and operating agreements to find out who owns the LLC, even if your name isn't public. Also, Wyoming law requires all domestic entities to either maintain at the registered agent's office or to file with the Secretary of State the name, business address and business telephone number of a natural person who is authorized to receive communications from the registered agent, and the names and addresses of the entity's directors, officers, managers or persons serving in a similar capacity. If, for example, the registered agent maintains this information and it includes the names of the LLC’s members, the registered agent could be served with a subpoena requiring it to provide this information.
You can also form your LLC as a DAO (Decentralized Autonomous Organization). A DAO can be managed by both human members and algorithms, unlike a standard LLC, which is only managed by people.
Whether you choose a standard LLC or a DAO, you must still meet certain requirements. These include having a registered agent in Wyoming who meets the state’s standards and filing an annual report.
Should I form a crypto S corp?
An S corporation is a corporation that provides its shareholders with pass-through taxation. By default, all corporations are taxed as C corporations, meaning the corporation pays a corporate income tax. To be taxed as an S corporation, the shareholders must all consent and the corporation must file the proper form with the IRS.
S corporations are similar to LLCs in that both offer asset protection and allow income to be taxed only at the individual level. However, there are important differences regarding ownership, management, and ongoing requirements. LLCs are easier to set up and manage compared to corporations, which need directors and officers and have to hold board and shareholder meetings.
LLCs are more flexible than corporations when it comes to the participation of the owners in management. In an LLC all members can participate in management. In a corporation, directors manage and shareholders are silent investors. Additionally, a corporation must allocate profits and losses to owners based strictly on their ownership percentage. In contrast, an LLC can distribute profits and losses in any way its owners choose.
One advantage of the S corporation is that S corp owners can choose to receive both salary and dividend payments, which can lower their overall tax bill.
One disadvantage is that LLCs usually struggle to attract outside investors aside from banks. (Although outside investors tend to favor C corporations over S corporations because C corporations can issue preferred stock. Also, S corporations cannot have other corporations or LLCs as shareholders which means no private equity investments.)
To qualify for S corporation status, a business must meet strict rules set forth by the IRS. For example, there can’t be more than 100 shareholders, with certain exceptions shareholders must be individuals and US citizens, and they can only issue one class of stock. In contrast, LLCs can provide pass-through taxation without all of those restrictions.
Ultimately, there isn’t a perfect choice between an S corporation (or a C corporation for that matter) and an LLC. Deciding whether to operate your crypto business an S corporation or LLC depends on several factors, including the type of business and the owners' short- and long-term goals.
