An initial important decision when starting a business is what business structure you should use to operate the business. If you don’t already, start considering owning rental properties your business.
Most small business owners wonder whether the limited liability company (also known as the LLC and sometimes referred to as a limited liability corporation) is necessary or whether a sole proprietorship is sufficient.
Liability Protection Is the Major Difference
When you form an LLC for your business, the law provides you with a layer of protection that protects you, the owner of the business against being personal liable for the debts, obligations and lawsuits of the business.
What this means is that if the business is found liable for an obligation, you will not automatically be personally liable for it merely because you are the owner of the business.
On the other hand, if you operate your business as a sole proprietorship, there is no such layer of protection. You are your business and your business is you.
What this means is that all of your assets (your home, your personal savings and retirement, your car, jewelry and anything you own) are at risk in the event someone sues for business related matters. Keep in mind; landlords are the number one sued industry in America. And property managers make the top ten list.
Likelihood of being sued
So, the main question is . . . given your particular business endeavor as a landlord/real estate investor, what is the likelihood and chance that your business will be subject to obligations and lawsuits?
Before you get into this inquiry for your particular situation, here are some important facts to consider:
1. Given the statistics, your chances of being sued are higher than your chances of being hospitalized in the next year and this likelihood greatly increases as you accumulate more rental properties.
2. Lawsuits are an epidemic in this country and small businesses that generate income are primary targets.
3. If you are sued (even if the case is frivolous and without merit, you will need to defend it which can require personal assets if you are personally sued.
4. Given the low cost to form an LLC and the ease of maintaining a limited liability company, lawyers and accountants universally recommend the use of such a vehicle.
5. If you have any assets at all, it is not worth taking the risk of losing them by starting a new venture without any liability protection.
6. Even if you do not have assets (or equity in your property) and your business is just beginning. . . if your business grows (equity increases) and becomes a valuable asset, it will become a prime target because it is generating money (lawsuits are always about money). Forming an LLC later does not protect you from actions and liability incurred prior to formation.
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Given the above information, the only time anyone would operate as a sole proprietorship business is if the nature of the business does not give rise to any liability potential and you do not have any real assets to lose.
Insurance is another way to protect against liability and should always be used as well. However, insurance policies can have exclusions and limitations, so the smart business owner uses both mechanisms to protect themselves and their business.
So, what can give rise to liability?
Whenever your business interacts with a third party, a chance arises. Common Examples include:
* A criminal act is committed on your property; such as rape or assaults
* Slip and fall of tenant or their guest
*Automobile accident involving you or an immediate family member
* You hire a contractor and there is an accident or business dispute;
* You have an employee and are sued for an employment claim
* There is a car accident in your parking lot or you have a store and someone falls in your store and is hurt.
* You sign a contract and do not read the fine details. Next thing you know, you are being sued for not performing under the contract.
* Your business borrows money and the bank sues to collect
* You enter into an order with a vendor and there is a dispute
Lawsuits are almost always about money. When your business becomes successful, there are so many creative lawyers out there that look for ways to extract money from you.
Without protection, you are an even higher target because they know they can reach not just your business assets but all your personal assets.
Many mistakenly think that an LLC is not necessary until you become successful. Forming an LLC later does not protect you from all business activity incurred prior to the formation.
The costs to Form an LLC are so low and given this liability protection as well as the other advantages of an LLC to a business owner, the use of this entity should be strongly considered.
Other Advantages of an LLC over a Sole Proprietorship
In addition to liability protection, the limited liability company offers several other benefits over a sole proprietorship structure:
1. More Trustworthy and Professional Image
Anyone can call themselves a sole proprietorship business but it takes a filing requirement to set up an LLC to operate a business.
Given the many fraudulent businesses and scams out there, customers prefer to do business with legal entity businesses.
By having a business vehicle such as an LLC, it shows that the business owners engaged in some business planning and were smart about properly starting their business. This results in differentiating your business from the many non-legal entities out there.
This makes it easier to get customers when starting and building your brand.
2. Less Risk of Tax Audit
Sole proprietorship businesses are where most of the small business tax fraud comes from when it comes to taking unlawful deductions. Without any formal filing requirements, many can claim they run a business to try to pay less taxes.
For the same reasons noted above in #1, the IRS understands that having a legal entity is one factor which differentiates legitimate businesses from the rest.
Of course, this is not all you need to do to reduce audit risk. You should also keep good records and accounting practices and file your taxes on time.
3. Better Structure for Raising Capital
A sole proprietorship is set up for a single owner. What this means is that if your business ever got to the stage where you want to expand and need to take in equity capital for the expansion, your sole proprietorship structure will not be acceptable to most investors.
Even if you find an investor that will work with a sole proprietorship, the costs to structure the investment will be exorbitant and the legal papers complex.
If you form an LLC and have an LLC, there is the concept of ownership interests in the legal entity. This creates an automatic and widely accepted structure for investors.
You may think that you can just convert or form an LLC at a later date if needed for this. The longer a business waits to convert, the more complex the transition will be. This can scare off your investors if the lead time and complexity is too high.
An LLC gives you a simple structure to operate from on day one but provides flexibility to evolve and change as your business grows.
4. Some Customers/Vendors Require Legal Entities
There is a strong movement today of business customers and vendors having policies requiring that they only do business with legal entities such as an LLC.
This is because the liability of doing business with individuals is too high.
A customer who wants to retain your personal services does not want to take the risk that the IRS will view you as an employee and not an independent contractor as this gives rise to liability for the customer.
5. Business Continuity
A sole proprietorship is not designed to automatically continue if something happens to the business owner.
By definition, a sole proprietor business is an extension of the single owner and so if the owner were to die or become incapacitated, the same thing happens with the business.
This is a huge nightmare for the heirs of the successful business owner. In contrast, an LLC is an entity separate and apart from the owner or owners. Accordingly, the business retains its life and characteristics despite what happens to owners.
Call today and schedule a no cost, no obligation assessment regarding your asset protection needs.
888-674-9181
Costs and Process to Form an LLC
The advantages of an LLC over a sole proprietorship are quite numerous.
The only concern would be whether the costs to form an LLC are prohibitive or the effort to maintain it is difficult.
Good news here as well: The legislatures of most states want to encourage small business and so they specifically enacted LLC laws to make it easy for small business owners to take advantage of all the LLC benefits.
It is true that an LLC requires some fees and paperwork. Just think of these resources as an insurance policy to protect a lot more.
It is really important that you form an LLC properly to ensure liability protection and other benefits. We take the guess work out of setting up an LLC properly. 1,000s of people have used us to create LLCs.
After formation, most states charge a minimal annual fee and/or the filing of a simple report each year to renew the registration. Some do not charge anything or require any additional filings.
Single Member Taxation is Same as Sole Proprietorship But With More Options
Many business owners have this mistaken fear that if they form an LLC for their business, the taxation will be too complex.
If you are a single owner and you set up an LLC for your business where you remain the single owner, the Internal Revenue Service treats your business as if it were a sole proprietorship. There is absolutely no difference in tax treatment for federal income tax purposes. . . however, you get all the state benefits of an LLC such as liability protection.
If you run a sole proprietorship business, you are limited to one taxation structure- sole proprietorship taxation. However, if you run your business through a single member LLC, your business has the option of being taxed pursuant to sole proprietorship taxation, C corporation taxation or S corporation taxation.
In summary, there is no tax difference to use an LLC for the single owner, but you get even more. If in your specific business situation, it may be more tax advantageous to use a corporation tax structure, you can do this with an LLC (not with a sole proprietorship). If this is a potential for you, contact your accountant to understand the differences.
Converting to an LLC from a Sole Proprietor at Beginning of Year Makes It a Little Easier
Start the New Year by Adding Personal Liability Protection
If you have been looking into converting your sole proprietorship to an LLC (limited Liability Company), there is no better time to do this than the end of the year or the very beginning of the next year.
This is because it makes the accounting must easier. You will not need to maintain accounting for two different businesses over one year. This also simplifies the tax reporting because you can have all your Scheduled business items on one schedule for the tax year.
In most states, you may be able to file and have an effective date of January 1st of the next year which is the best option because you will have your legal entity and more importantly liability protection in place starting with a beginning of year date.
It is always a good idea to start an LLC as soon as possible if you are running a sole proprietor business but if your decision is also coming up around the start of a new year, this is an even bigger reason to move forward.
