Why Establishing An LLC May Not Be Enough to Protect Your Business.
Establishing an LLC does NOT automatically mean that you or your assets are automatically protected. Gasp!
Disclaimer: This content has been made available for informational and educational purposes only and is not meant to be a substitute for legal, accounting, or other professional advice. If you have specific questions about any legal matter, you should consult with an attorney or other professional services provider.
If you’re in the process of turning your idea into a legal business entity, forming a limited liability company (LLC) is an attractive option. Most businesses cite that the primary reason to establish an LLC is for protection from personal liability or to protect your business assets, should anything happen to your business.
This is a great idea! Remember, the wealthy do not own things in their personal name. Their businesses own assets, and they enjoy the benefits of those assets while mitigating liability.
However, there are some misconceptions about the extent to which an LLC can protect you…
#1. “I have an LLC and liability insurance coverage, so I don’t need to keep an attorney on retainer.”
I’d like to ask you, “What happens to your insurance coverage or premiums when you use that liability insurance policy?”
The insurance carrier may drop you at your next renewal date, meaning that you may become unable to conduct business depending on your industry, or significantly raise your premiums a few months after your claim.
Ask a business owner who has endured a lawsuit and had to file an insurance claim. They will inform you through gritted teeth how the premium increase was tantamount to the expense of keeping legal services on retainer.
#2. “My LLC covers all of my tax burdens.”
Establishing an LLC is not a tax strategy. Most tax and accounting professionals will encourage entrepreneurs to set up their LLCs as disregarded or “pass-through” entities. This literally means that the business entity is disregarded and the tax liability “passes through” the business to YOU.
There are 2 important tax seasons. There is tax filing season, and tax planning season. Don’t get caught in tax filing season, before having undergone tax planning season first. During your tax planning season, consult with financial and legal professionals who understand business financing and tax planning.
Remember that professionals specialize. There is nothing smart or profitable about disregarding this important point. It’s not what you know in business that kills you, but rather what you don’t know. The average accounting professional reports that entrepreneurs miss out on tens of thousands of dollars in tax deductions and relief annually, because they choose professionals who do not have experience assisting individuals in their specific personal and business situations. Hire financial and legal professionals who frequently assist individuals and businesses similar to yours.
As a granular tip, if you own multiple LLCs you may need to submit multiple K-1 filings. This creates a bureaucratic nightmare for new entrepreneurs, greater expenses, and a host of other unintended consequences. Consider setting up a management company to manage all of your LLCs. Note: Always remember to consult a business planning professional who specializes in your area of law as you make legal structuring decisions.
#3. “My LLC automatically protects all of my assets.”
Establishing an LLC does NOT automatically mean that you or your assets are automatically protected. Gasp!
To reiterate an earlier point, most LLCs are set up as single-owner, disregarded entities. Meaning that legal liabilities also pass straight through the LLC to you. The first clue is in the term “limited” liability companies. When an LLC is structured this way, it is more or less operating as an extension of you, offering limited protection.
There are rules that must be followed and suggested guidelines to ensure that the corporate veil of separation between you and your LLC is not pierced:
Avoid commingling personal monies and business revenues. Business revenues should be deposited into a business deposit account, and you should pay yourself by transferring money from your business account to a personal deposit account. If you intend to buy groceries, do so from your personal account.
Many states require annual filing fees and other bureaucratic steps to ensure compliance
Acquire an operating agreement. The operating agreement for an LLC delineates each member’s ownership percentage, rights, and responsibilities. While an operating agreement is not legally required, having one can help settle disputes. In other words, you don’t have to tie your shoestrings in the morning, but you should do so to avoid tripping and slamming your face.
Develop the habit of recording monthly corporate meeting minutes. While corporate minutes are not legally required, doing so once again can help settle disputes.
If desired, you can set up your operations in such a way that it can be argued the LLC was set up simply to hold assets (very relevant to real estate investors) and for no other business purposes. This is beneficial when an investor owns property through an LLC and there is a lawsuit related to the property (e.g., an injury on the property), only the assets within the LLC are at risk, not the investor's personal assets.
Think about it like this: Lawsuits are business decisions. The math for the opponent boils down to, “How much can I expect to extract from you, after subtracting out the cost of an attorney and other expenses needed to prevail in court?” While it is not foolproof, think of your LLC as a financial deterrent.
Take the first step towards elevated performance by scheduling your consultation with JSB Business Solutions. Click this link and schedule a day and time that works best for you.
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