Setting up the proper legal structure for your business may seem like a boring detail that you won’t need to spend much time on. But the truth is, selecting the right entity for your company is one of the most crucial decisions you can make as a business owner.
That said, there are all sorts of myths and misconceptions surrounding business entities that can cause confusion and lead to costly mistakes for those who fail to do their homework when establishing a legal entity. To this end, here are 4 of the most common myths about business entities and how you can avoid falling for them.
Myth #1: Professional practices or small businesses don’t need to worry about their business entity structure.
Although you can certainly run a business without setting it up as a business entity, doing so puts you—and everything you own—at risk. Without the proper entity set up, there’s no separation between your business and personal assets, so your personal assets would be up for grabs in the event of business debt or a lawsuit.
For example, if your company is structured as a sole proprietorship or general partnership and you go out of business, your business creditors would come after your personal assets to pay off your business debts. The same is true if your business is ever sued.
By structuring your business as a limited liability company (LLC) or a corporation, however, you can shield your personal assets from liabilities incurred by your business. When properly set up and maintained, such structures establish your company as a separate legal entity distinct from you as an individual, preventing you from being held personally liable for the company’s debts or legal disputes.
Myth #2: There’s no need to set up an entity for your business until it’s proven successful.
It may seem like a good idea to delay setting up your business entity until you are actually turning a profit, but in reality, you should have your entity in place from the very start. This is true not only because liability risk can arise well before you are making a profit, but also because incorporating your business is likely to lead to more income and profit.
For example, having the proper entity in place in the early stages allows you to receive credit in your business’ name (and if structured correctly, it won’t show up on your personal credit report when you use it, preserving your credit score), as well as allow you to raise money from investors, if you choose. Not to mention, the act of incorporating itself shows that you take your company seriously, which can inspire increased confidence and support from others, including potential customers, vendors, and financial backers.
Myth #3: A corporate entity offers absolute liability protection.
When properly created and maintained, entities such as an LLC or S-corporation, can shield your personal assets from creditors, lawsuits, and other disputes incurred by your business. However, the personal liability protection afforded by these entities is not absolute.
Indeed, there are a number of circumstances in which a creditor can come after your personal assets to settle a claim against your business. When this happens, it’s known as “piercing the corporate veil.”
While the corporate veil can be pierced if you commit fraud or negligence, in most cases, it happens due to innocent mistakes. These errors can include inadvertently mixing your personal and business finances, personally signing off on a business loan, or failing to abide by administrative formalities. Be sure to work with an experienced attorney on an ongoing basis to ensure you are maintaining your corporate shield by handling your business affairs properly, keeping its assets separate from your personal assets, and checking in with us before you sign any and all agreements on behalf of your business.
Finally, while a corporate entity can protect your personal assets from liability, these legal structures do not offer any protection for your business assets. To safeguard your business assets, you’ll need to invest in the proper business insurance, which is always your business’ first line of defense.
Myth #4: Incorporating in Delaware, Nevada, or Wyoming is always better.
You may have been told—perhaps even by another lawyer—that establishing your corporate entity in Delaware or Nevada is your best bet for tax purposes. But for most businesses, incorporating in these states is completely unnecessary—and it may even cost your company in the long run.
Although many companies do incorporate in these states, it’s for very specific reasons, such as to raise investment capital or take advantage of favorable securities laws to go public. However, unless you are actually doing business in these two states, your company isn’t going to receive any significant tax benefits or additional asset protection by incorporating there.
While Nevada and Delaware do not have state personal- or corporate-income taxes, that doesn’t mean your business will avoid state-level taxes entirely. The fact is, if you are a resident of, or doing business in, a state that has state income taxes, you must still pay those taxes, even if you are incorporated elsewhere.
Plus, if you incorporate outside of the state where you live or conduct business, you must file as a foreign registrant in your home state. Such double filings can result in extra filing fees and administrative expenses that make out-of-state incorporation financially unfeasible.
That said, there are instances where it might make sense to set up your business entity in states like Delaware or Nevada, but trying to use incorporation as a tax loophole isn’t one of them. Such instances involve asset protection, but choosing which state to set up your business in should be done carefully.
Make an Informed Decision
Setting up the appropriate entity for your business isn’t something you should take lightly or try to do all on your own—there’s far too much at stake. You should work with an attorney that can offer you trusted advice on the legal entity that’s most advantageous for your business and help ensure it’s set up properly
You will also want to ensure you stay in full compliance with the various state laws and administrative formalities required to maintain your entity, protect your assets, and increase the chances of success for your business and your relationships over the long term. Contact us today to get started.
Dahl Law Group
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