In order to protect one’s personal assets from liability, setting up a corporation or limited liability company (LLC) may be the answer. Both of these types of legal structures offer what is termed limited liability, which means that there are limited situations when these entities will not protect the owners, who are termed members (for an LLC) or shareholders (for a corporation) from personal liability. In most cases, these types of companies will protect the owners from personal lawsuits and collection against their personal assets if the corporation or LLC is sued.
An example of how this protection works is if the LLC or corporation defaults on a bank loan, then the member or shareholder will not be responsible for the repayment of that loan as long as the member or shareholder didn’t personally guarantee it. Or, if someone fell on company property and was injured, that injured party could only go after assets owned by the corporation or LLC and not the personal assets of the owner like the family home or car.
Lawyers, accountants and other professionals can take advantage of the protection offered by corporations and LLCs by setting up a professional corporation (PC) or a professional limited liability company (PLLC). However, these types of entities will not protect the member or shareholder professionals against malpractice.
Small companies with less than 100 shareholders can take advantage of a special designation under the tax code called a Sub Chapter S. Usually, corporations and their shareholders would be subject to double taxation, which means that the corporate profits are taxed and then the shareholder is personally taxed on their income from the corporation. However, when a corporation is set up as a Sub Chapter S, the corporate profits are not taxed; rather, they pass through to the shareholders and are then taxed under their personal tax returns.
In single-person LLCs (only one member), the profits of the LLC pass through to the member and there is a box on their tax return that is checked confirming that the profits are from a single-member LLC. If there is more than one member who is not married, then a partnership tax return must be filed and the profits from the LLC are handled with that return. Note that one can also set up a limited liability partnership in those cases, but a partnership tax return will still need to be filed.
A single member LLC is advantageous in that no additional tax return has to be filed by its members. In contrast, a corporation must file a corporate tax return each year, adding an additional expense to its shareholders. However, the initial set-up of an LLC is more expensive than a corporation because with an LLC there is a requirement that the new LLC initially publish its existence in the newspaper once a week for six successive weeks in the county in which the LLC office is located within 120 days of its inception. If the LLC fails to do so, then it cannot legally do business and cannot take advantage of the New York Court System.
There is a caveat concerning the protection provided by corporations. Corporations must operate under strict guidelines in order to retain their corporate protection. For instance, they must conduct annual shareholder’s meetings and select directors for the transaction of business on a date fixed by the bylaws. However, the secretary of the corporation may make a statement concerning notice of waiver of the meeting, and then just read the minutes of the last meeting. If the corporate guidelines are not followed, a creditor may be able to “pierce the corporate veil,” and then go after the shareholders personally, claiming that the shareholders operated the corporation as an “alter ego.” LLCs do not require any of the types of strict guidelines that corporations do. Limited liability companies are simple to run and save the single members money over the long run by not requiring additional tax returns.
Both corporations and LLCs offer limited liability to their shareholders and members. Each has a unique set of rules, initial start-up procedures and filing requirements. One must consider which entity is right for their business and consult with a professional accountant and attorney to make that final choice.
Rick S. Cowle is an attorney admitted to practice law in New York, Connecticut, the District of Columbia and the United States Supreme Court. He is president of The Law Office of Rick S. Cowle, P.C., a general practice law firm located at 18 Fair St., Carmel. He can be reached at 845-225-3026 or RCowleLaw@Comcast.net. For more information, visit RCowleLaw.com. This article is meant for informational purposes only, and is not intended to create an attorney-client relationship or to give legal advice.