Are you a new business owner?
Then, you likely have questions about whether to declare your entity a limited liability company (LLC) or a sole proprietorship. You may even owner if a partnership or a corporation makes more sense.
These are essential questions that impact the future of your business and how you’ll handle everything from finances to taxes. They also have significant implications concerning the protection of your personal assets from business debt and lawsuits.
We refer to this as LLC protection.
You may have also heard that there’s a lot of paperwork associated with LLCs, and you feel hesitant to dive into the bureaucracy.
We’re here to tell you, though, that forming and running an LLC proves much more straightforward than creating a corporation. It also requires less paperwork. Let’s dive into the process so that you can put LLC protections to work for you.
What Is a Limited Liability Company?
An LLC shares some characteristics with a corporation and some with a sole proprietorship. Yet, it remains separate from its owner. However, unlike a corporation, an LLC is considered a “pass-through” entity.
What does this mean? In essence, the IRS sees the income as passing through the business to its owners. That means you still report an LLC’s profits and losses on your personal tax returns like you would with a sole proprietorship or a partnership.
So how does an LLC protect your private assets if you report profits and losses as personal taxes?
Despite this “pass-through” designation, an LLC’s owners remain protected from personal liability for business claims and debts. If your business accrues debt that it can’t pay to a lender, supplier, or landlord, you’re not left holding the bag.
Why? Because an LLC’s assets can only get utilized to pay off business-related debts. That means you only risk losing the money you’ve invested in the LLC, hence the “limited liability.”
LLC Exceptions to Know About
Of course, there’s a caveat to all of this. While LLC owners have limited personal financial liability for many of their business transactions, these protections aren’t without exception.
Note, however, that these drawbacks aren’t specific to LLCs. They also apply to corporations. So, what can you be held responsible for as an LLC owner?
For one, if you directly and personally injure another individual, you’ll get held financially responsible. You’re also accountable if you guarantee a business debt or bank loan with private assets, and then your LLC defaults on payment.
If you neglect to deposit taxes withheld from your employees‘ wages, the represents another area where personal liability kicks in. The same goes for LLC owners who act in ways that are intentionally fraudulent, reckless, or illegal.
You can ensure liability by treating the LLC as an extension of your personal affairs rather than as a separate legal business entity. Here’s more to keep in mind when it comes to successfully piercing the corporate veil.
Treating an LLC Like a Separate Legal Entity
Let’s dig more deeply into the last point as it’s, perhaps, the most important on the list. If you, as an LLC owner, don’t treat your business as a separate legal entity, you risk incurring liability.
If a court decides, based on past actions, that you’re not conducting business like an LLC owner, they’ll rule your legal status nonexistent. That means the court has concluded you’re doing business as a sole proprietor and should be held liable.
What can you do to ensure you operate your LLC properly? Here are a few tips to keep in mind:
- Act in a way that’s fair, transparent, and legal
- Keep you LLC and personal business entities separate
- Fund your LLC well
- Create an operating agreement
Why are each of these steps so important to the courts? How do you execute them to best position your LLC? Here are some best practices to follow.
Follow These Steps to Keep Your LLC in Good Standing
When it comes to acting fairly and legally, you must remain above reproach and suspicion. In other words, never misrepresent or hide facts about your finances from vendors, outsiders, or creditors. Period.
You should also take pains to keep your private finances separate from those of the LLC. If you can’t respect this fundamental principle, then don’t expect the courts to do so either.
As for adequately funding your LLC, make sure that you invest enough cash into the LLC so that it can meet all of its foreseeable liabilities and expenses. This approach represents a basic principle of good stewardship and not one you should overlook.
Finally, you must create a formal written operating agreement. When properly executed, this document lends additional credibility to your business practices and the right to be called an LLC.
Other Things to Know About LLCs
Besides following these LLC best practices, you should shield your assets even further by paying for a good liability insurance policy.
If you end up with a lawsuit on your hands, the policy will cover your LLC. It’ll also provide extra protection for your non-business-related finances.
A liability insurance policy can also protect your personal assets should a court decide to reverse your LLC status.
That said, there are exceptions. For example, liability insurance won’t cover your LLC’s unpaid debts.
You should also understand that under the laws of many states, if one member leaves you LLC, then the entire entity gets dissolved. You can avoid these unpleasantries by including a “buy-sell” or buyout provision in your guidelines.
LLC Protection Your Company Needs
Creating an LLC starts with filing “articles of organization” with the LLC division of your state government agency. Of course, you don’t want to forget about other steps and documents, such as your operating agreement and guidelines.
That’s why you should work with a company that can guide you through the process, ensuring you don’t miss any steps or neglect to meet compliance along the way. That way, you know your LLC protection is bulletproof.
Interested in more ways to help your company succeed? Browse our business blog for game-changing tips to put you at the head of the pack.