We live in litigious society. Businesses that are organized as sole proprietorships are taking on unnecessary risks. One way to manage these risks is to form a Limited Liability Company ("LLC"). The owners of an LLC are called members. If it is just the sole proprietor that is going to own this entity, this would be known as a single member LLC. If, however, someone wants to bring in their spouse or someone else as an owner, then it is known as a multi-member LLC. Having a sole proprietorship exposes not only the assets in the business, but all of the personal assets of the proprietor. An LLC will limit the liability of the owner to the assets in business.
There are some formalities which should be followed so that the LLC will be acknowledged. The purpose of using this entity is to limit the liability of the owner. There are no tax advantages. For example, a sole proprietor will file a Schedule C, “Profit or Loss from Business”, as part of their individual income tax return. A single member LLC would also file this form.
Here are some of the practical steps business owners should take to have a LLC:
- Have an operating agreement. If you have questions filling out an operating agreement, you should consult with a licensed attorney.
- Maintain a separate business checking account. Caution should be exercised by only having business deposits and expenses run through this account.
- Obtain a federal tax identification number, if necessary.
- Have letterhead, stationary, invoices and contracts say "LLC" after the company name. These steps will help document that the business is holding itself out to the public that this entity is an LLC.
Cost Benefit Analysis
The costs to form an LLC are fairly modest. There will be an attorney fee to set up the entity and some filing fees. There may also be some ongoing fees. In Connecticut, there is an annual Business Entity Tax of $250. This is filed on Form OP-424. These costs are not significant compared with the liability protection that is received.
ACTION ITEM: All sole proprietors should take a very hard look at converting to an LLC.
Thomas F. Scanlon, CPA, CFP®