SOLOPRENEUR: WHAT YOUR LAWYER ISN’T TELLING YOU Pt. 1

Solopreneur: I see too often that solopreneurs want to form a corporation or an LLC, but for all the wrong reasons. Here’s the 411 on if a solo business owner should form a business entity.

There’s generally three or four reasons to form a business entity: liability and asset protection; tax reasons; availability of insurance; and to obtain loans.

Liability Protection for the Solopreneur

Let’s talk about the one reason why forming an entity may not be worthwhile, and that is liability protection. Solopreneurs have been misled (from my experience) that forming a corporation will protect them from liability. However, that’s just not true.

Start with the premise that you are always liable for your own actions. Always. No amount of corporate shielding can protect you from the legal consequences of your own negligence. So you work for BigCorp and run a red light while making deliveries, you, personally, are still responsible for any damages you cause by running that red light. Always.

Now, BigCorp may also be liable for damages because of your negligence because you were performing their task at the time of the accident. But even though BigCorp may be named in the lawsuit, you, individually, will always also be named. There is no legal way to shift your own negligence onto some other entity. The payment of damages may come from BigCorp, but only after you, individually, are found liable.

The factors I look at when advising my clients whether to form a solo business, regarding liability protection, is what their potential exposure is, and whether someone else (like an employee) can cause a liability event for them. So if your business is making cute stuffed animals from old socks, your potential liability is very low, there’s probably no reason to form an entity just for liability protection purposes.

Solopreneur and asset protection

Because there’s always going to be individual liability for a solo, you won’t get the asset protection that a business entity can provide. If you sign an office lease, or an equipment lease, or even a loan, you’ll almost always be required to sign a personal guarantee. That personal guarantee right there negates any asset protection for commercial contracts (as opposed to negligence-like liability).

Sure, having a layer of entity-owned assets for a creditor to garnish gives you some protection. However, most personal guarantees are directly enforceable. That means that a creditor like a landlord or vehicle financing company can go directly to you, individually, to collect on the debt. It’s rare to see a lease or finance agreement that requires the lender to go after the business assets first before coming after the guarantor (you).

Tax Reasons for a Solopreneur to Form a Business Entity

Similarly, for a small, one-person business, there may be no tax benefits to forming an entity. A solopreneur can take most of the tax deductions that a formal business can take. The only reasons I’ve seen (but talk to your qualified business CPA!) for a solo to form an entity is if the income is so great that there’s a benefit to putting you, the owner, on the payroll to account for part of the income, and to pay the rest as profits.

That way you may also be eligible for unemployment if the business goes South. I guess if your business is one that may be subject to tax breaks for that kind of business, it would be a second good reason to form an entity if the accrediting agency requires it.

Conclusion

Just setting up a corporation or limited liability company may not protect a solopreneur from liability. Similarly, there may not be any tax reasons to do so.

Stay tuned for Part 2 of why your business lawyer might not be telling you everything you need to know about starting a solopreneur business.

If you need a business lawyer in western North Carolina, call me at (312) 671-6453 or email me at palermo@palermolaw.com for guidance in getting it done.

Listen to my podcasts on business law here: BIZRADIO BUSINESS LAW PODCAST

Check out some of my other business start-up posts Why Online Legal Documents Are Useless for Business (Part 1) and Business Succession Planning: Why You Need It

And here’s a link to my LinkedIn profile because SEO says to have outbound links: MY LINKEDIN PROFILE