Choosing the Form of Your Business Entity: Sole Proprietorship or LLC?
By: Patrick Blair
As an attorney, one of the most common questions I get from friends and acquaintances is: “should I form an LLC or a corporation?” I usually respond by asking, “have you considered a sole proprietorship?” For most new business owners, the real question is: “should I form a sole proprietorship or an LLC*?” (This article will not address the relatively small nuances between an LLC and an *S corporation, nor will it examine C corporations, partnerships, or tax issues.)
The decision can be difficult, because the primary difference between these two business forms is the potential limitation on personal liability, which is an abstract concept for most. To measure its value, you must gauge your business’s potential liability. For example, a skydiving operation has massive potential liability, while a freelance musician would have relatively little.
You should also factor in whether or not you have significant assets to protect. If you have little to protect, you might consider starting as a sole proprietor. As your assets grow, you can reevaluate whether or not to convert to an LLC.
To complicate matters, protection from personal liability is not guaranteed. You can be held liable if the ‘corporate veil’ is pierced. To avoid this, you must maintain the corporate form and not act as the ‘alter ego’ of the entity. Obedience to corporate formality is a burden you shouldn’t accept lightly. You should carefully weigh the burdens against the benefits of forming and operating an LLC (see the chart below).
LLC or S Corporation
(-) Filing costs that typically run between $200-500 depending on the state
(-) Following corporate formalities when necessary
(-) Annual fees and other associated fees; annual filing requirements
(-) Possible need for separate tax return; more complex tax issues
(+) Potential liability protection
(+) Clout associated with having a corporate entity
(+) Some tax benefits
The decision is yours! Keep in mind that you can later choose to convert from one form to another. If you choose to form an LLC or an S Corporation, there are a number of resources online that can help you perform the necessary filings. Of course, you can contact an attorney to assist you, but you will typically pay a premium. In any situation where you will have a business partner, I highly recommend seeing an attorney (whether you form a partnership or an LLC).
I would like to add one last note about insurance. Insurance may be more important than whether you form an LLC or not. Forming an LLC is not a substitute for insurance. Just because you have an LLC does not mean someone or some company couldn’t sue you individually (along with your LLC).
Even if you bankrupt your corporate entity, you could pay a lot in attorneys’ fees to prove that your corporate veil should not be pierced. Incidentally, not having insurance is one of the grounds for piercing the corporate veil. The right liability insurance provides coverage not only for paying liabilities, but also for a defense (i.e. attorneys’ fees and costs).