Happy New Year! The beginning of the year is a good time to start some things fresh. If you are like most people, you probably have some lofty goals about losing the holiday weight. And if you are like most business owners, you probably have some goals about improving your business this year (faster, better, stronger, more profitable, more organized, less stressful, etc.).
Goodness knows, starting Thanksgiving, I feverishly review my goals and accomplishments, scramble to accomplish stale tasks, and read motivational books like the 31st of December is the end of days.
And as I consider my year-end profitability, I think about taxes and liabilities (a lot) and consider how I can do things better next year. Because both taxes and liabilities cost me money and take up my time without giving me any return on investment, I want to minimize them as much as possible. Taxes and liabilities are blocks to my business’s growth and success.
If you are a business, the turning over of a new calendar year it is a good time to think about your liabilities, legal documents, tax situation, sunk costs and corporate structures. Let’s start with this: if you are not incorporated but you are doing business (even as a micro-business), you should incorporate immediately. Right now in fact. Here’s our incorporation package: New Business Legal Jump Start.
But even though I recommend you incorporate, you may be surprised to learn that you can still be liable for torts, employment law actions, and debts as the owner of a closely-held corporation or LLC (meaning you have less than 35 owners). When I tell my clients this, they usually argue with me.
“But I keep all the bank accounts separate!”
“But I thought that was the whole point of incorporating!”
“Why bother to incorporate at all???”
Unfortunately, the law is complicated and fickle. But that does not mean you should not take advantage of the corporate form. You just need to understand its limitations. Please let me explain.
First of all, you should incorporate so that you pay less taxes. Jeff Cane at Expert Accounting (and someone with whom I’ve worked since 2010) recently shared a PDF with me (Sole Prop vs S Corp). He broke down the tax savings of an S Corporation over a Sole Proprietorship in a hypothetical microbusiness. The tax liability was reduced by thousands of dollars.
But you should also incorporate to avoid liability. And this is where people get confused. You see, the point of the corporate veil is to prevent you from being liable as the business owner of the torts and debts of others, including the business, particularly when you have no ability to control them or prevent them. But it does not mean you can act with reckless abandon in the name of the business. Some of that liability still comes through.
You see, a tortfeasor is always personally liable for their own torts even when they commit the tort while at work or in the name of a business. (Translation: you are always personally responsible for the wrongs you personally do.) The business may also be jointly or vicariously liable (i.e. equally and concurrently responsible). And (here’s where it gets tricky) when you own a business, and that business commits a tort, it is possible that, as the owner of the business, you are also considered to have personally committed the wrong based on your own actions in controlling the business (without anyone having to pierce the corporate veil). Let me give several examples.
Let’s say you are a small business. You bake and deliver cakes. You have only a couple of employees. You have a cake to deliver one day and you do it yourself. While driving the cake, your run a red light and hit another car. Even though you were delivering for the business, you are also personally responsible for the accident. The fact that you incorporated does not relieve you from personal responsibility. But it may make the business equally responsible with you.
In contrast, let’s say you own a bakery and you have 100 employees. One of your employees is delivering a cake, runs a red light and gets into an accident. You do not know that employee well, had no reason to think he would drive negligently that day, have good company training and policies, and did not even know he was going out to deliver that cake. In that situation, the company and the employee are both liable, but not the business owner personally.
And another example: you are the small business cake baker again. You send an employee out to deliver a cake, but know that he’s a terrible driver, it’s snowing, and the delivery is late so it is foreseeable that he will drive hurriedly. In that case, depending on a number of factors, you may be personally liable when he blows through that red light, despite the fact that you incorporated, because you decided to send him out under those conditions.
Similar rules apply to debts (when they are incurred in bad faith or fraudulently, both of which are torts) and certain employment actions (i.e. sexual harassment, which is sort of like a tort). You may also enter into a separate contract to guarantee a debt (this is common with small businesses), which makes you personally liable for the business’s financial burdens even you otherwise would not be.
Some of this makes sense to me — you shouldn’t be able to commit fraud and then hide behind your corporation. But with respect to negligence and certain torts like trespass and conversion, I feel like they create an unfair burden on small businesses that does not exist against big businesses. Sometimes, if you are a small shop (like most businesses are), being incorporated may do you no good if you get personally sued for certain torts. Indeed, I recently defended a very ugly lawsuit where the owner of a business was personally on the hook for a business conversion because a security lien had not been perfected before a repossession. One paperwork error can devastate a small business owner!
But that being said, it is still worth incorporating to protect against liability. Why? Because of all the things it does protect you against. For example, most wrongful termination claims are still only against the company and not the owner. Most wage claims are charged against the corporation and not the owner. Most debts are charged against the corporation and not the owner. And there is even some coverage for torts. Plus, there are a lot of lawyers who do not know that torts may carry direct liability and so they try for alter ego instead (something I can usually win in defense). So perhaps incorporating is a little like taking shelter in a house with a leaky roof; that’s far better than no shelter at all!
Savvy business owners keep different assets in different buckets (like your business cash in a corporate savings account and your personal residence in your own name or a trust). It is a good idea to split your assets up so that they are sheltered. You work hard to earn your money and build your business; “bank” it whenever you can.
Do you know whether your papers, titles, contracts, corporate records and potential business liabilities are in order? Don’t wait until you get a tax bill or get sued to find out that a paperwork error can bankrupt you. Get a Business Risk Review and find out or contact our business law attorneys for a consultation at (800) 889-8376.