Volume 2 Issue 1 -- January/February 1998
When should you incorporate? Twenty years ago, this question was a "no brainer" and the answer was almost always "Incorporate, NOW!" In the ancient past of 20 years ago (before the Internet), the tax advantages of incorporating were pronounced, so the decision to incorporate was relatively easy. Currently, since "your" (not "the") Congress has taken away nearly all of the tax "goodies" derived from forming a small corporation, the decision to incorporate, or, in the alternative, form a Limited Liability Company, is not quite so simple.
Adding to the complexity of choice is this "new kid on the block," the Limited Liability Company. Aside from sounding terribly British, what the heck is a Limited Liability Company ("LLC")? Perhaps the best shorthand method of describing an LLC is to say it is a partnership which, like a corporation, provides limited liability to the owner-partners.
"Fine," you may say, "so corporations and LLCs are similar, but that still doesn't answer the question, why form either one?" In the good "ol'" days, before we had an income tax, businesses formed corporations to protect the investor-owners from unpredictable liabilities, like a ship sinking at sea.
Hundreds of years ago, the then new entities, the precursors of modern corporations, provided investors a way to invest in a risky new world venture without "losing the castle if the ship sinks." Stated differently, the risk of investing in the colony of Virginia could be segregated from Lord Wadbottom's other wealth, and his potential liability from investing in diamond mines in Manassas would be "limited;" hence, the British term "Limited," referring to what we outcast colonists now call "corporations."
Even if you don't have Lord Wadbottom's wealth, you may have a home or other assets worthy of protection. Let's say you have employees driving delivery trucks or preparing food. Should you have limited liability? Yes. Why? Suppose your delivery truck driver hits a school bus? Or your chef believes the "white powder" in the kitchen was flour, but, actually, it was insecticide?
Each reader can create their own horror story where an employee causes harm and you, the owner, get sued. If there is no entity like a corporation to protect the business owner, the horror story becomes reality. Personal assets can be subject to the claims of injured parties, which explains this newsletter's reference --these injured parties are "jumping over the fence" and getting your personal assets.
While you may not own a castle like Lord Wadbottom, would you want to become impoverished because your teenaged delivery boy is looking at his testosterone-inflated biceps instead of the road? Even though the delivery boy and his corporate employer could be sued, the owner of the corporation, in most cases, would not be at risk. Newland & Associates advises its clients to look at the risks. If the risks are significant, then incorporate or form an LLC.
What if you are a bookkeeper with no employees and you do everything yourself? Do you need to be incorporated or form an LLC? Probably not. Why? If you are operating alone, whatever harm is done would be done by you, the person doing the books. Being incorporated or forming an LLC will not protect an individual from personal liability for his or her acts. Don't fall into the mental trap of many businesspeople who naively believe that if they are incorporated, they cannot be sued should they individually make a mistake or cause harm.
For example, if you own an incorporated business and hit a pedestrian while you're driving the corporation's car, then you, as the driver, will be sued individually. Being incorporated will NOT protect you from that kind of individual liability. (Similarly, your muscle-bound, testosterone-loaded delivery boy will be personally sued if he causes vehicular harm, and he may lose his entire collection of Screaming Weasels hits.)
In the same vein, incorporating will not protect you from corporate contractual liabilities you have personally guaranteed. This is why lenders to small and medium-sized businesses usually insist upon personal loan guarantees from the principals. By obtaining personal guarantees, the lender has the ability to "get at Lord Wadbottom's castle," so to speak, even if the Lord's corporation or LLC fails. This type of personal contractual liability is virtually inescapable unless Aunt Mildred loans your LLC money.
"Insurance is the answer," you say. "I will buy a large multi-risk policy and not worry." That may work if you get a large enough policy, keep it current, and the insurance company does not fail. Few policies, however, are large enough to cover the "big hit," the unexpected school bus type of accident.
Occasionally, a company to which you provide services may insist that you incorporate even if you are the only one providing services. The reason such demands are made is to reduce the possibility that you, the independent contractor (worker), will be reclassified by a government agency and be deemed to be an employee. In that event, the company receiving your services will owe back employment taxes and other benefits because you have been reclassified. Being incorporated will not categorically avoid reclassification, but should reduce the likelihood of it.
Don't incorporate or form an LLC just because someone told you to. As in all business decisions, there should be a reason for it. If you have questions about this, or other, business choices, call Newland & Associates. Next time, we shall discuss Lord Wadbottom's business contributions to the peruke industry.
Published by the law firm of Newland & Associates, PLC
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