Friday, February 15, 2013

The importance of forming a business entity separate from your personal affairs.

Regardless of the field of industry in which you conduct your business, there are clear benefits to forming a business entity. There are a few different options from which one can choose, and they each have their own advantages. Some advantages are tax-related. Some advantages are related to liability. The primary reason one should form a business entity separate from their personal affairs is liability. Every business is vulnerable to legal claims. No matter how you careful you are in conducting business, you can find yourself in trouble because of another person's actions. So it is important to be protected.

If you run your own business, but do not have it set up as a separate business entity, then any legal claims against you can be asserted for the full amount. If you have $100K in household assets, and a $75K judgment is entered against you, the judgment debtor (the person who sued you) can obtain $75K from you personally. Now, consider a situation in which you formed a business entity and kept those assets and liabilities separate from your personal assets and liabilities. If you have $25K in business assets and do not commingle your business and personal finances, then the same judgment debtor who has a $75K claim would only be able to recover $25K from you (provided you formed a business entity with limited liability).

If you have a spouse, and have joint bank accounts, the first scenario penalizes them, because a $75K judgment was entered against you personally and you share a bank account with them. In the second scenario, the judgment is entered against your business, and only up to the value of the business's total assets.

If you step back and look at the big picture -- the effect of business entity formation -- think of it as a form of insurance, but paid with a very small premium. Essentially, you pay a small biennial fee (low three digits), and your liability is limited the value of the business's assets.

If you do not pay the small biennial fee, your business entity is dissolved, and you are personally liable again. To maintain limited liability, you have to select an entity with limited liability. Also, you must keep your personal and business finances separate from each other. I cannot stress that enough.

No comments:

Post a Comment