The COVID-19 pandemic has changed the lifestyles of countless Americans. Many have lost jobs or had to shift their focus to home schooling their children. Others have started working from home and have been considering the possibility of opening their own business.
Perhaps you’ve are an entrepreneur. Or maybe you want to hang your own shingle in law, medicine, or similar professional field that requires a license to successfully practice. Regardless of your new chosen path, it’s important to address the top three considerations of liability protection, tax implications, and management style to help fast-track your fresh start.
Choosing a corporate entity
What’s my novel business idea? What will I name my company? What should my company logo look like? As important and fun as those decisions may be, there’s the matter of whether you should form a sole proprietorship, a limited liability company (LLC), or a corporation.
It’s important to note that your eventual corporate entity will be governed at the state level and not by federal law. A careful review of the laws of your home state should be the first step in your decision-making process to ensure your new firm’s compliance with applicable state law.
In California, for example, your options in forming a corporate entity are limited to either a professional corporation or a limited liability partnership (LLP) if the profession you’re in requires a license to practice. This includes medical and dental professionals, lawyer, architect, accountant, etc. “That’s because of the heightened level of liability, and duties owed to the public. The state also restricts ownership and requires certain levels of Insurance,” said Jennifer R. Trowbridge, Esq., Junior Partner with Jacko Law Group.
Consideration No. 1 – Liability Protection
“With a professional corporation, it’s codified you must have certain minimum insurance in place to ensure the public is kept safe from potential malpractice.. There’s a higher duty owed to the public from these professionals in California, and you must have these provisions in place.”
Additionally, protecting one business owner from the actions of the other business owners is Important. You should review the statutes in each state in which you are considering and incorporate appropriate limited liability provisions in your Bylaws and/or Operating Agreement in order to help shield personal assets from company assets, and shield the owners from each other. “There’s the question of putting each member in their own little bubble that protects them from the actions of other members,” Trowbridge said. I’ve seen quite a few member-gone-rogue issues.”
Consideration No. 2 – Tax Implications
A best practice in starting any business is to surround yourself at formation with talented, capable people who excel in such specialty areas as law, taxes, and accounting. Tax laws vary from state to state. An advisor can help determine whether you’d be better off forming an LLC for the potential benefits pass-through taxation can provide.
“Sometimes, "pass-through" is not the best based on the personal financial situations of an owner,” Trowbridge said. “Having a tax advisor help analyze whether pass-through or corporate taxation is the best structure for the members involved is a very important consideration.”
Trowbridge cites another example of how a tax advisor can add value.
“Let’s say a real estate agent wants to no longer operate as a sole proprietorship, and they form an LLC,” she said. “But they make themselves the sole manager and the sole member. In most states, California included, it is unsettled whether the assets of a single-member LLC are protected from personal creditors and vice versa." The IRS considers a single-member LLC as a disregarded entity, but California requires additional fees and taxes. It’s important to fully understand all the obligations and implications.
Consideration No. 3 – Management Style
One of the benefits of an LLC, as opposed to a corporation, is that you have some flexibility as to how you want the company to be managed. You can set up the LLC to be member-managed, manager-managed, or even managed by a board of managers.
“Sometimes it’s difficult to fully understand the difference between member-managed and manager-managed,” Trowbridge said. “If they just use an online formation service priced at $99, it’s going to default to a management style and they may not fully understand the implications.”
Trowbridge recalls one case in which several family members were forming an LLC for a family business. They thought the LLC would be member-managed (all of them participate in the decision making). The LLC was actually set up as manager-managed and one of the members appointed themselves as manager and thus had control of the day-to-day decision making.
“Having a full understanding and working knowledge of how varying management styles factor into choosing a corporate entity is huge,” Trowbridge said. “It can prevent fights and huge, costly debacles later on.”
Set Yourself up for Success
Starting a new business can be an intimidating exercise. No one person has all the answers. The experts at Jacko Law Group can work with you to address areas of concern and help sidestep potential landmines on your new path. Peace of mind can be priceless. Contact us at 619.298.2880 or firstname.lastname@example.org to schedule a strategy session.
- Jr. Partner
Jennifer Trowbridge, Esq. serves as Jr. Partner at Jacko Law Group, PC (“JLG”) where she provides corporate and regulatory counsel to clients with diverse business models and various backgrounds. Within her practice, Ms ...
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