Tag Archives: liability

Business Strategy , , , , 2 Comments

Limited Liability Company — Should Your Business Be an LLC?

by

Going into business invariably entails lots of decision-making,  one of which will be to choose the legal structure of the business entity.  As you know there are three choices: Sole Proprietorship,  Limited Liability Company and Corporation,  typically S Corporation for Freelance consultants and small business owners.  Most Freelancers begin as Sole Proprietors and many remain there.  If business-related liability is not an issue,  then that is a perfectly acceptable choice.  About 70% of  US businesses are Sole Proprietorships.  However at some point in the life of your business,  perhaps as revenue and reputation grow,  it may be preferable to move beyond Sole Proprietor status.

At any time,  you may decide to operate your Freelance consultancy through an entity that limits your personal liability as the owner  (alone or in partnership),  decide that it’s worth the  $500.00 or so filing fee  (payable each year on renewal),  plus maybe three hours of attorney or accountant fees to make sure everything is done the right way.  Or maybe it’s not liability you’re worried about.  Maybe you feel that you’ll appear to clients and prospects more  “real”  and the legal structure is more marketing tool than liability protection.  Whatever your motive,  the matter of selecting your consultancy’s legal entity will present itself.  Should you structure your business as a corporation, or as an LLC? The answer to the question is— it depends.

Most Freelancers and small business owners are directed by their accountants and attorneys to the LLC.  It’s flexible and easy to set up and file.  Your state’s Secretary of State’s office will have a form online for you to inspect.  There may be one or several owners of the LLC,  but there must be a registered agent  (to receive mailings associated with the LLC entity)  who resides within the state.

A big advantage of organizing your business as an LLC is that you will receive protection from creditors of the business.  If the business owes money,  those to whom it owes money will not be able to come after personal property and other assets.   Moreover,  limited liability means that business owner(s) may not be held liable for debts that exceed their investment in the business.  For example,  if your investment in your Freelance operation is $5000.00 and you manage to incur business debts of $8000.00,  you are potentially liable for only the $5000.00.

Furthermore,  there is no separate business tax on the LLC.  All business income and expenses  “pass through”  to the owner(s) of the business,  who pay personal taxes only on the net profit,  based on the share of business ownership.  The owner of a single-entity LLC does not have to file a separate tax return for the business—all financial information is reported on form 1040.  Schedule C Profit and Loss for a Business must also be filed  ( you file schedule C also as a Sole Proprietor),  where one may deduct all of the allowable pre-tax business expenses,  i.e. advertising expenses,  travel and entertainment,  office supplies, etc.  You must also pay self-employment tax,  as do Sole Proprietors.

I was surprised to learn that an LLC can own property.  In fact,  if the property owned increases in value  (and it probably will),  your LLC will avoid the capital gains double taxation that regular corporations  (C Corporations)  would incur should the property be sold or the business entity liquidated.  Like business expenses and profit,  the capital gains would  “pass through”  to the owner(s).

One must be careful when doing business as a separate legal entity,  though.  Your LLC cannot become entwined with personal finances.  Keep your grocery store charges,  shopping sprees and personal vacations out of your business affairs.  Failing to do so will cause LLC status to be forfeited.  Moreover,   an LLC terminates if one of the owners retires,  resigns, dies or goes bankrupt  (remaining owners can form a new LLC).

The LLC works best in relatively straightforward businesses,  single- or multi-owner.  If your goal is to raise money to vastly expand your business,  then the business is advised to incorporate,  so that investors will have the security of holding stock certificates as proof of ownership stake in the business.  Ditto if you plan to take your company public.  I’ll be back next week with a look at incorporating your Freelance consultancy.

Thanks for reading,

Kim

Business Plan , , , Leave a comment

Starting A Business? Consider Your Legal Entity Part II

by

The type of business that you are in will guide your choice of legal entity.  If you are a solo Freelance consultant, then operating as a Sole Proprietor is most likely appropriate. However,  if your business exposes you to liability, then it is highly recommended that you spend a few dollars and protect your assets by establishing a separate legal entity. Many business entities evolve as they grow, transforming from Sole Proprietorship to Limited Liability Company to Corporation.

LIMITED LIABILITY COMPANY

The  LLC is a relatively new option.  It creates a separate legal entity and may be used by a solo entrepreneur or a multi-owner business.  It is required that an EIN be obtained for the business and a certificate of organization be filed with the Secretary of State, along with a fee of about $500 paid annually.

There is no limit on the number of owner–partners in an LLC.  A certain degree of protection from liability is granted, as in an S Corporation.  It is highly recommended (but not required) that in a multi-owner LLC an operating agreement be written that names a managing partner and other specific partner roles and responsibilities.

Single owner LLC tax filing is similar to the Sole Proprietorship.  On April 15  you file schedules C and SE and form 8829 if claiming a portion of your home as an office. Quarterly estimated taxes are due on the 15th of January,  June and September reported on form 1040–ES.

Additionally,  an LLC with 2+ members must file form 1065, the informational Annual Return of Income.  Owner–partners file form 1040 with schedules E and SE,  plus estimated quarterly taxes on form 1040–ES.

Be advised that an LLC is dissolved in a bankruptcy or upon the death of a partner.  Include contingency plans in the partner’s agreement so you don’t find yourself in business with the spouse or children of the deceased, for example.

GENERAL PARTNERSHIP

A partnership is a non-corporate legal business entity that is formed by 2+ people (or entities) who desire to do business as co-owners.  GPs can be formed by individuals, corporations, estates or trusts.  This classification also includes joint ventures and syndicates.

A GP is not a separate legal entity,  so there is no requirement to register the partnership with the state.  Partners will be on the hook for any business liabilities, including unauthorized actions by partners who acted on behalf of partnership business interests.

Absolutely, write a partnership agreement.  Include the purpose,  goals,  partner contributions and responsibilities.  Management duties, decision making power, permissible and restricted business activities outside of the partnership and financial matters such as access to financial records and expense authorization should also be specified.

Moreover,  spell out how profits and losses will be distributed, the penalties for failing to fulfill responsibilities and contributions and the procedures to follow should a partner die.

Partners are taxed on the income/losses of the partnership on schedule  C, filed with their personal 1040, along with form 1040–SE self employment tax.  The partnership as an entity must file form 1065 Annual Return of Income on April 15.  Quarterly estimated taxes are due on the 15th of January,  June and September.

LIMITED PARTNERSHIP

This format is similar to the GP, with the exception that a partner(s) agrees to contribute resources to the business entity without becoming involved in its day to day affairs.  These are “silent partners”, often investors.

LPs have a share of ownership but neither operate nor manage the business or act officially on its behalf.  They have a liability to the business and its creditors that is proportional to what they have invested.  LPs and GPs receive a share of business profits/losses based on percent of ownership.  Again, it is recommended that an agreement for LPs be written.

As with  GP, form 1040 with schedule C and form 1040–SE will be filed on April 15 and quarterly taxes reported  on 1040–ES and filed on the 15th of January,  June and September.

More next week and thanks for reading!

Kim

Business Plan , , , Leave a comment

Starting A Business? Consider Your Legal Entity Part I

by

SOLE PROPRIETORSHIP

The default legal identity for the vast majority of Freelance business consultants, the Sole Proprietorship is an extension of the owner and is not a separate legal entity.  It is possible to use a separate business name (dba = doing business as) when operating as a sole proprietor—registering with the state and /or city can be a good idea—and it’s also possible to obtain from the IRS a separate business tax ID (Employee Identification Number, or EIN) and open a business bank account, both of which are recommended.  Sole Proprietorship offers no liability protection.

The tax return filed is your own.  Since there will be business expenses,  you will file schedule C along with 1040.  Deduct the portion of your home used for business on form 8829 Use of Home for Business.  See your P & L for the numbers to use for schedule C business deductions.

Quarterly estimated taxes must be paid on the 15th of January,  June and September along with the annual filing on April 15.  Remember to file the self employment tax schedule SE in April.

SMALL BUSINESS CORPORATION

To form an S Corporation is to create a separate legal entity for your business.  You must file articles of incorporation;  write by-laws for the corporation;  and elect a board of directors and officers.  It is furthermore required that annual meetings of corporation shareholders and directors be held and  official minutes for all corporation meetings be written and retained.

To set up an S Corp. choose a name for  your business (check the name availability on your state website),  get an EIN number and call the Secretary of State’s office to receive filing instructions.  The fee is about $275, paid annually.  It is recommended that you trademark your business name.

This is a relatively new form of corporate status.  As in the standard corporation, called the C  Corporation, owners and shareholders in the business are issued stock (of one class only).

To operate as an S Corp., certain conditions must be met:  the business must be a small business, must be based in the US,  may consist of 1 to 100  shareholders only  and no shareholder can be a nonresident alien.  Business owners and the business will have limited protection from liabilities, providing that no owner has been proven to be negligent.  If an owner is proven to be personally negligent, the owner will be held personally liable.

The tax return filed is the owner’s  form 1040, along with schedule E (due April 15) plus form 1120S (due March 15).  As with any business, quarterly estimated taxes must be paid, in this case using form 1120W.  Shareholders file schedule E along with their form 1040. There is no separate corporate tax.

If this is the business entity that you elect, be careful to meet and maintain all of the conditions.  Meaning, even if you are the sole owner, you must still hold annual meetings and write and retain minutes.  Failure to meet these conditions can cause you to lose the tax advantages of  S Corp. status and the business will be re-classified as a C Corporation.

CORPORATION

Known as the C Corporation, this is the granddaddy of separate business entities.  C Corp. status offers more protection against liability than any other business entity.  If you run a large business, if your business has locations in more than one state,  if the business is expected to be very long lived  and/or if the business could be subject to significant liability,  it is worthwhile to operate as a C Corp.

Stock will be issued (of any class) and stock options can be offered.  It is generally easier to raise investment capital, as stock and/or options can be made available.  On the downside, a C Corp. has comparatively larger administrative expenses, is subject to more regulatory scrutiny and is taxed at a higher rate.

To do business in this fashion select a name for the business, obtain an EIN number and file articles of incorporation with the Secretary of State for a fee of  about $275, paid annually.  It is recommended that the business name be trademarked.

Corporation by-laws must be written and a board of directors and officers must be elected.  An annual meeting must be held for directors and officers and meeting minutes must be written and retained.

The corporation  must file the annual tax form 1120 on March 15,  plus estimated taxes on form 1120W on the 15th of  April,  June,  September and December.  Business owners file form 1040 with schedule E on April 15 plus estimated quarterly tax payments on the 15th of January, June and September using form 1040–ES.

Next week, I’ll be back with 3 more options for your business legal entity.

Kim