PART 2 – Legal Entities – LLCs
There are two types of legal entities (a sole proprietorship is not a legal entity – it is not recognized by the IRS or MA DOR, and it does not provide any legal protection) – a limited liability company (LLC) or a corporation. (Yes, there is also a partnership in its different iterations, but it’s really beyond the scope of this discussion and unrelated to the common questions prompting this post.)
In short, LLCs are like “corporations light”. They were brought into life as a way for small businesses to create an entity that isn’t subject to the same rigid formalities as a corporation. Easier to run, more fluid, and less cumbersome. They are typically what is recommended by attorneys and CPAs to budding new entrepreneurs (depending, obviously, on the details of the business and ownership).
The main point of creating an entity is to create a legal barrier between your business obligations & debts, and your personal assets. Think of it as a moat protecting your treasure in your castle. An added bonus to creating this legal moat is that it allows for certain tax benefits. A sort of fiscal moat for the money your business adds to your treasure. (CPAs & EAs may say the tax benefits are the primary reason and the legal moat is the benefit, but that’s because CPA/EAs are wild maniacs. I kid.)
Now imagine a hoard of bandits wants your treasure. They surround the moat and start slinging arrows and fireballs from wooden trebuchets. (Yes, I was a big GoT fan, but I will leave out the dragons because, honestly, they mess up my metaphor). If your moat is built right and filled with water (and sharks with freaking laser beams, why not) and your castle is also surrounded by a high solid wall, then your treasure is safe. Eventually, the bandits run out of arrows and fireballs, food, or energy. Maybe they die during the siege. Maybe you’ve got some wicked bad-ass lady archers up on the castle walls picking them off. I digress. The point is, if it’s all done right, you, the castle, and your treasure are safe.
But!! If there are stones missing in the walls creating gaps, or there’s a rotten tree that’s fallen across the moat, or the moat has no water (or sharks), the bandits and their arrows and fireballs can, and will, get in. And now your treasure is vulnerable.
I am sure you are all following the metaphor. The bandits are lawsuits, denied insurance claims, collections, defaults, etc. The treasure and castle are your home, your savings, your retirement accounts – it’s the assets and wealth you’ve built and accumulated. Your LLC filing is the moat. The water in the moat and the stones in the wall castle wall are all the other things you need for protection: your insurance policies, your operating agreement, the practice of keeping your personal funds and business funds separate, the filing of your annual report, your proper record keeping, and your actions as a business owner.
Can you, your CPA, or an online service file your LLC Certificate of Organization? Sure, it is just filling in blanks and paying the fee, after all. Does that mean you understand what you just filed (or someone filed for you), maybe – maybe not.
Does that mean you are an LLC? Yes, in name.
Does it mean you are running your LLC the right way and have all the pieces in place to ensure that you are actually getting the protection of the LLC? NOPE.
All an online (or mail-in or fax) filing means, is that you filled in the blanks with satisfactory information, paid the fee, and aren’t using the same name as another MA LLC or Corp. That’s it. It’s just a moat. Without the other parts in place, you have no water, no wall, no sharks with freaking laser beams – and that’s where an attorney comes into play. It’s something LegalZoom won’t supply and your CPA/EA shouldn’t supply (because that would be the unauthorized practice of law and good CPA/EAs know better than to do that, even the wild maniacal ones).
If your business is ever sued – maybe someone slips and falls in your boutique, or you are accused of breaching a contract – or if your insurance fails to pay a claim against your business because you weren’t covered, or did something grossly negligent, or against your policy (and as the saying goes, insurance companies are not in the business of paying claims) – the other person is going to do everything they can not only to seek compensation from your business but also from you as an individual. Why? Because going after two defendants doubles their chances of collecting. If they can show that your LLC is in name only (they point out the rotten tree, empty moat, and missing stones) then they can storm the metaphorical castle and plunder your not metaphorical personal treasure.
Maybe you don’t want water, or sharks, or stone walls, or think it’s too expensive. That’s up to you. But then paying the $500 (plus another $20 if you file online) every single year, seems like a waste. If you don’t want the full protection of the LLC, then why pay the fee annually? Maybe you really only care about the tax benefits, in which case you’re willing to take the risk that the entity doesn’t hold up under scrutiny or assault. But that seems silly. If you only set up the LLC for the tax benefits, why not reap the legal protection as well?
There are most definitely areas where you can confidently handle some of your own legal work. You can file small claims on your own, you can use services like LegalZoom for simple, straightforward templates. File your own d/b/a. File for trademark protection within the state with the Commonwealth of MA. Heck, if you and your soon-to-be ex-spouse can work together, you can actually file an uncontested divorce on your own.
But unless you understand the nuance of the LLC statute and the relevant taxation, setting up a properly formed and functioning LLC should be a team effort with you, an attorney, and a CPA/EA.
Here’s the TL;DR: yes, you can file your own certificate of organization for your LLC on your own; yes, you can hire a service; no, you don’t get the same legal protection if that’s all you do; CPA/EAs are your friend but not your lawyer; I am a bit of a dork.
Next up – Part 3 (and the stirring conclusion) – Corporations