Should you start thinking about asset protection?
Do you own your own business? Have you been thinking about how better to protect your home and other assets from potential creditors? May a limited liability company (LLC) or a corporation be right for you?
If you own your own business as well as personal assets such as a home, you should seriously consider forming either an LLC or a corporation to protect your assets in the event that you are sued.
While there is very little you can do to protect yourself against getting sued in our litigation-happy society these days, you can arm yourself against frivolous lawsuits by ensuring that your assets are as difficult for creditors to reach as possible. One easy way to do so is by forming either an LLC or a corporation to separate out your business assets from your personal assets, thereby restricting the availability and type of assets that potential creditors can access from you.
So what is the different between an LLC and a Corporation?
Both are legal entities registered with the California Secretary of State that limit your personal liability for your business’s activities. An LLC is a hybrid business entity, bringing together some of the best features of partnerships and corporations. LLCs were created to provide business owners with the liability protection that corporations enjoy without the double taxation. Earnings and losses pass through to the owners and are included on their personal tax returns. In other words, you don’t have to file your taxes any differently using an LLC than you would if you remained a sole-proprietorship, yet you automatically separate out and protect your personal assets from potential litigation. The owners of an LLC are called its members. A further advantage of an LLC is that if you are only a limited member, meaning you do not have any management rights in the LLC, then you are only liable for the debts of the LLC up to the amount of money or assets you contributed to the LLC in the first place. In California, you can have a single member owned LLC or any number of members. However, once you have more than three or four owners, a small business should consider forming a corporation instead.
A corporation is an independent legal entity owned by shareholders. This means that the corporation itself, not the shareholders that own it, is held legally liable for the actions and debts the business incurs. While there are two types of corporations, c-corps or s-corps, most small businesses will be interested in forming as an s-corp so they can avoid the “double-taxation” that results from c-corps. S-corps are taxed the same way as LLCs, meaning that the earnings are “passed-through” to their members who report their earnings on their individual tax returns. However, there are some disadvantages to an s-corp that you do not encounter with an LLC.
So what is the difference between an s-corp and an LLC? While s-corps and LLCs are very similar, there is no limitation on the number of shareholders an LLC can have, unlike an s-corp, which has a limit of 75. In addition, any member or owner of the LLC is allowed a full participatory role in the business’s operation if he or she wants; in a limited s-corp partnership, on the other hand, partners are not permitted any say in the operation.
LLCs also allow for the “special allocation” of profits–the disproportionate splitting of member profits and losses in different percentages than their respective percentages of ownership. This means that members can enjoy the benefits of receiving profits, and writing off losses, in excess of their individual ownership percentage. The managing member of an LLC can also deduct 100% of the health insurance premiums he or she pays–up to the extent of their pro-rata share of the LLC’s net profit, because the profit is considered earned income. If a member has earned income, he or she will also qualify to deduct 100% of the health insurance premiums he or she pays.
While both LLCs and corporations can provide you with asset protection, LLCs are slightly easier for most people to manage as the required “corporate formalities,” such as holding annual meetings (and recording their minutes) are much more lax than those of a corporation.
Another great benefit of forming either an LLC or a corporation for your business? You can deduct a large number of business expenses from your taxes, such as the use of your corporate vehicle and other fringe benefits!
The cost of setting up an LLC is roughly equivalent to setting up a corporation. The secretary of state’s fees for filing articles of organization and for filing statements of information are similar for LLCs and corporations. Entrepreneurs who wish to seek help in organizing an LLC through an LLC formation service or through an attorney will find the fees to be roughly the same.
Call the Palm Desert Law Group today for a free consultation to see whether an LLC or a corporation might be right for you and your business.