Do the poor get sued?
No, there’s nothing there to take.
It’s the wealthy that get sued because there are assets available.
The first step entrepreneurs need to consider as they open their business is whether to form a legal entity or remain exposed as a sole proprietor.
Let me explain.
If you start a business, get paid, and pay taxes with your social security number then you are a sole proprietor. You don’t have a formal entity such as an LLC, S-Corporation or other structure that owns the business.
So, what’s the big deal?
Should anyone sue your “company” for any reason, they have access to all your personal assets also. Your home, cars, bank accounts – everything you have worked hard to build and save for retirement can be drained in one lawsuit.
So how do you protect yourself? By setting up a formal entity that owns the business.
Having a legal barrier (corporate veil) between you and your business is one of the most critical items for entrepreneurs to have in place.
This will limit liability, potentially save on taxes, position the business for sale or other exit strategies, and look more reputable to prospective clients.
What Business Structure Should You Choose?
Is an LLC or S-Corp the best for your business? What about structures such as Non- Profit, Professional LLC, DBA, LLP, LP?
Rather than giving you the boilerplate answer of “it depends”, I wanted to provide you with some practical examples of what I have used.
Real Estate: I have always used LLCs for ownership of my real estate properties. They are easy to set up and have a lot of flexibility. Additionally, in most states, LLCs offer you with both Inside and Outside protection.
Inside – protection of your personal assets if there a lawsuit against the property.
Outside – protection of your properties if there is a lawsuit against you personally. Check with your state to see if they offer outside protection.
The LLC also enables you to move entities around without incurring a taxable event (as with a C-Corp).
Partnerships: I also use an LLC when I have companies with partners. This offers the best flexibility on who has ownership and how the distributions or salaries will be paid.
My “Payroll” Company. I use an S-Corp for the entity that pays for my salary, medical benefits, and expenses specific to my home office, company car and other deductions.
An S-Corp is known as a “pass-through entity”. That means any money left over after paying for all expenses of the company is directly passed through to the owners – without being taxed at the company level. The money will be taxed at a personal level.
The diagram below shows the relationship between these entities.
This simple structure provides protection for personal assets, your businesses, and your business partner. It also provides you with the ability to manage your own retirement plans, distributions, salaries and deductions such as hiring your children.
What Questions Should I Have Answered Before Setting Up the Company?
The information above provides you with the more common entities used by entrepreneurs.
To ensure you select the best entity, you should work with an attorney and your tax professional. Both professionals will have input and need to work together to find the best solution for you.
We found two simple tools to help prepare for the meeting with your professionals. Both offer questions and provide their recommendations. This is not an extensive list of questions your attorney and tax professional will ask, but it does provide you with a nice introduction to the type of questions they may ask.
MyCorporation’s Entity Choice Wizard
Biz Filings’ Incorporation Wizard Tool
How Do I Create My Entity?
I strongly recommend working with an Attorney and tax professional when setting up your entity. It will cost you $400-$1,000 but well worth the investment. Setting up your entity incorrectly or missing some key items may cost you a lot more in the long run.
But wait – there’s still an important question you need to answer:
“What state should I incorporate in?”
There’s a lot of debate over this topic. We will break it down for you in next week’s article.