Creating a business entity may not be the most exciting aspect of starting your own business. However, it’s an essential step in protecting your business that can save you from unwelcome (and expensive) surprises. There are plenty of myths and misconceptions about what business entities are, what they can do, and who should have one. Whether you’re starting a side hustle or embarking on a whole new venture, you don’t need uncertainty and confusion in your business. Here are five LLC myths and misconceptions about business entities that may be holding you back.
MYTH #1: Small businesses don’t need an LLC.
This one could fall under any number of names, but they all boil down to the word IF. It’s unfortunate how many people believe “I don’t need an LLC if…”
- I have a home-based business.
- We don’t have any employees.
- We make less than [X amount].
- My business is just me.
Yes, it’s possible to set up a company without a business entity, just as you can skateboard without a helmet. But when things go wrong, your losses can be significant. A limited liability company (LLC) provides similar protection to a helmet by creating a barrier between your business liabilities and your personal assets.
Without a proper business entity, your personal and professional lives may be viewed as one—making you vulnerable to lawsuits and potentially serious debt. For example, if your company is structured as a sole proprietorship or partnership and you go out of business, creditors would come after your personal assets to satisfy your business debts. The same is true if your business is ever sued.
On the other hand, if you operate as a separate legal entity, you won’t be held personally liable for the company’s legal disputes or debts. However, your entity must be properly established and maintained with all legal formalities in order to keep this protection. We can help with that when you schedule an intro call.
MYTH #2: There’s no need to set up an LLC for your business until it’s profitable.
We all drag our feet with important tasks, such as reviewing our taxes before April (wink, wink). However, setting up your business entity as soon as possible should be at the top of your list.
There are two main reasons for this:
- Liability can arise long before you are profitable. Action attracts risk. If you are taking orders, renting office space, or earning revenue, you should have your company established now.
- Incorporating your business is likely to create higher income and profits. The act of incorporating demonstrates that you take your company seriously, which can inspire greater interest from customers, vendors, and investors.
With the right entity in place, you can use your business name to raise capital from investors, apply for credit, start marketing, and claim tax credits. The earlier you’re established, the sooner you’re protected.
MYTH #3: Corporate entities offer absolute liability protection.
An LLC or corporation shields your personal assets from business liabilities—but the protection afforded by these entities is not absolute.
There are some circumstances in which a creditor could seek your personal assets to satisfy a claim against your business (known as “piercing the corporate veil”). The corporate veil can be pierced for fraud or negligence, but in most cases, it’s pierced due to inadvertent mistakes, such as:
- Personally signing off on a business loan
- Mixing your personal and business finances
- Failing to abide by administrative formalities
- Failing to maintain accurate financial records
When it comes to avoiding LLC mistakes, it pays to be prepared. Suitable business insurance should always be your first line of defense to help shelter your business and safeguard your personal liability.
MYTH #4: Organize in Delaware or Nevada for tax benefits.
The LLC myth of organizing in a different state is evergreen. You may have been told to establish your corporate entity in Delaware or Nevada because they don’t have personal or corporate income taxes. The latest social media fad (and terrible advice) is to organize in Wyoming. The truth is, incorporating in these states is completely unnecessary for most businesses—and it may even cost you in the long run.
Companies that incorporate in other states do so for specific reasons—such as raising investment capital or taking advantage of favorable securities laws to go public. However, unless you’re doing business in these states, your company won’t receive significant tax benefits or extra asset protection by incorporating there.
Organizing in another state also:
- Doesn’t guarantee your business will avoid state-level taxes entirely. If you reside or do business in a state that has state income taxes, you must still pay them even if you’re incorporated elsewhere.
- Makes filing more complicated. If you incorporate outside of the state where you live or conduct business, you’re required to file as a foreign registrant in your home state. These double filings can result in additional filing fees and administrative expenses.
- Won’t necessarily keep business dealings private. The trend of incorporating in Wyoming is based on the privacy that the state offers. However, this “privacy” is useless if someone intends to do business in a place other than Wyoming.
That said, there are instances where it might make sense to incorporate in Delaware, Nevada, Wyoming—or even South Dakota. Your trusted legal advisor can determine the best location to establish your entity and help you navigate state and federal requirements for maintaining it.
MYTH #5: “I already have an S-Corp.”
This one drives me up a wall every time I hear it. It usually stems from another common misconception: that LLCs and corporations (and sometimes S-Corps) are the same thing. LLCs and corporations are both legal entities (with very different requirements). An S-Corp is a tax structure—not a legal one.
Let’s clear up the confusion:
- LLC structures provide corporate protection with pass-through taxation (profits and losses are reported directly on the individual members’ tax returns). There are fewer regulations regarding an LLC’s internal operations, making it significantly more flexible than a corporation.
- Corporations must comply with formalities to be legally valid, such as appointing a board of directors and holding annual shareholder meetings. They also have regulatory requirements like record-keeping, annual reporting, and corporate governance.
You can have an LLC or a corporation that’s taxed as an S-Corp. Depending on your needs, you may want to speak with us about electing S-corp status.
Helping You Get Back to Business
Setting up the right entity for your business isn’t a DIY-friendly task. At Yolofsky Law, we provide experienced legal guidance to help you choose the most advantageous business entity and ensure it is properly created with all necessary agreements and resources in place. Email us at hello@yolofskylaw.com or schedule a call today to start your new venture off right from the start.