Food for thought for the would-be entrepreneur (part 5 in a series)
In an earlier article, we brushed up against the concept of “protection from exposure to legal liability,” and we’ve seen that there is absolutely no such automatic protection for the sole proprietor. It is for this very reason that so many people opt to become a sole member LLC. (Sole member LLC = single member LLC = sole LLC = single LLC.)
LLC stands for Limited Liability Company. It can have many owners/partners, or just one. The name says it all: liability has now been limited. For a simple filing fee,* you’ve created a whole new entity with its very own federal ID number.
[ *This fee varies by state, but in NJ is still only $125. ]
For tax purposes, the LLC still files on Schedule C as a sub-form of your personal 1040. At the federal level, you will be subject to self-employment tax in addition to regular income tax. At the state level, you will just be subject to income tax. And yup: you are still a disregarded entity. (Out of context, this is such a terrible phrase.)
And now a word of caution: just because you paid a fee to acquire that limit to liability does not mean you don’t need insurance. Depending on your activities, this could still be a requirement, rather than just a good idea.
And a second word of caution: just because you paid a fee to acquire that limit to liability does not mean that you can’t inadvertently lose it! Depending on your business practices, you could shred that protection. Keep separate bank accounts for business and personal needs. Don’t comingle credit card use, either. Example: Groceries are a personal expense. If you buy coffee for the office, it gets its own receipt.
Every time your purchases share a receipt or bank account or credit card, you are chopping away at that nice thick liability wall that you purchased. The smallest nick can be enough for someone to claim it isn’t really there at all. The most likely party to make this claim is the IRS (and the second is your state.) The most likely time for such a claim to be made is during an audit. This means, a business audit turns into a personal audit, and vice versa. Do you really want every stray deposit into your personal checking account to be considered business income? This would apply to that $500 check from Aunt Tillie for your birthday, and the coin-counting deposit of all those coins you saved up for the last 10 years.
Best practice is to immediately set up separate banking. Today, many banks will allow a sole LLC bank account to show up on your personal online banking page. This allows you to easily transfer money between accounts, and provides an excellent paper trail.
Worst practice is to write a check a $1000 check from one of the accounts, and only deposit $900 of it in the other (taking the extra $100 in cash.) Don’t do this! (Oh, the troubles I’ve seen from this…)
Take steps to keep your credit and debit cards and purchases separate, even if you have to paste a big shiny star on one of them to make it obvious. If you do make a mistake and spend $88.88 on the wrong card, immediately reimburse the other account for the exact amount, preferably by check, and save that receipt. Maybe having to do so much extra work will remind you to be more careful the next time.
On a personal level, my only misgiving about this entity is that the technical, legal term for the owner/founder is “member.”