Why Do You Need An LLC?

By PAUL S. SIAN | FEBRUARY 1, 2016

There may come a time when small business owners are confronted with the question of why do you need an LLC (also known as Limited Liability Company)? Is there something special that an LLC can provide to business owners that would nudge them towards getting an LLC versus operating on their own without any type of business operating form?   The biggest benefit to be had with an LLC is that of protecting ones’ personal assets from a debt or legal liability which may arise out of the business activities.

Like a corporation an LLC is a legal designation for your business. An LLC can be run by a solo business owner, as a partnership amongst different people or can even be owned by other corporations or other LLCs. An LLC provides the limited legal liability similar to what corporations have but offers the flexibility tax wise to be treated as a partnership or as a sole business owner. The federal government and most states don’t treat an LLC as a separate entity for tax purposes as a corporation is normally treated.   (For more information see https://www.sba.gov/content/limited-liability-company-llc)

The primary benefit for the LLC as mentioned above is shielding your personal assets from legal liability for a possible wrong committed by you or one of your employees while operating the business. Say for instance you run a food based business where you prepare meals for others to purchase. If someone was to get sick after eating your food and blamed you for the illness (whether your food was the cause of the illness does not really prevent someone from suing you if they believe otherwise), they could sue you for any injury suffered as a result of the food poisoning. On the basic and not very expensive side a claim could request something basic as paying for lost work days as well as some compensation for pain and suffering. At the extreme end if a person required extensive hospitalization due to the food poisoning or death was a result, those claims in the lawsuit could be quite large and therefore expensive.

Where a lawsuit resulted in an costly claim against you and you don’t have limited liability company protection, the person suing you could seek recovery by going after your home, your cars, your savings, your kids college funds, retirement accounts and more. Even where some of your assets may be protected by state laws (homestead exemption for your home, retirement plan exemptions) the liability amount you owe does not go away unless you file for bankruptcy. What once started out as a business to help you make extra money has now become a liability that affects the money and assets you personally own. Having an LLC can limit your liability to just those of the business assets in the event of a lawsuit.

Types of Businesses Where You Would Want an LLC

As noted above a food based business in one to definitely consider having an LLC, as it is advantageous to protect your personal assets from any legal issues coming from operating that type of business. There are also plenty of other types of businesses to consider the LLC for and in fact you may want an LLC for just about any type of business you run in order to have that added layer of protection. Businesses where you interact with people on a daily basis is a perfect example of where the LLC protection can come in handy.

One example of a business with regular interactions with people include cosmetic type businesses where you are applying makeup, creams, hair treatments and more on your paying customer. If someone were to have an allergic reaction to a hair dye that causes them to lose hair or suffer some sort of rash a lawsuit could be an end result. You can have all the signed disclaimers/waivers in the world to try and protect you, but if it is shown you are in some way negligent those disclaimers will not protect you.

Another business example where LLC protection is great to have is where you are driving people around or delivering products for pay.   In this case if someone were to get injured while you are driving them around or delivering something (i.e driving for Uber, Lyft or some other ride sharing company) you may be on the hook personally for any injuries suffered. While some of the ride sharing companies have insurance to cover your passengers (and maybe even cover you) they also are hoping your primary insurance covers any damage or injuries first and they will come in second to cover any claims.  A problem that could arise is your own insurance company denies coverage to you and any fare paying passengers since you did not disclose to the insurance company that you are transporting passengers in your car for pay.

Insurance and ride sharing is a complex topic that I will cover more in depth in a future article, but for purposes of this LLC article just know that if you don’t tell your insurance company that you are transporting people for pay they could deny any claims for injuries or damage resulting from your “business”. If your insurance company won’t pay, and the ride sharing company pays for only part of the claim or decides not to pay anything at all, your personal assets are at greater risk than if you had LLC protection.

How The LLC is Run is Also Important 

Properly managing and operating the LLC is also critical. If the only thing you do is fill out the LLC paperwork, send it in to your local state business authority and nothing else, you will have little to no protection for personal assets in a lawsuit. With an LLC you must keep your personal and business assets separate. That means separate bank accounts, keeping separate your business expenses from your personal expenses, separate financial records and more. If you fail to keep the LLC separate from your personal assets a judge can find that you are not operating a true LLC business thus opening up your personal assets to be used to cover any damages you may pay to settle a lawsuit.

Having insurance for you and your business is also always advisable. When talking to your insurance company you should ask them about their umbrella policy option. Make sure you inform the insurance company about what your business does and the fact that you have an LLC that needs to be covered under the umbrella. Umbrella insurance policies are good to have since like an umbrella they provide good insurance coverage for you personally and for your business activities for many different types of claims that don’t necessarily fall under your homeowners or auto insurance policies.

For tax purposes, depending on the type of LLC you have setup and how you want to run your business there may be little to moderate change come tax filing season. Ultimately the profits you earn from running your business get reported on your tax returns. Doing the tax portion correctly and using all the correct forms is one piece of evidence that shows your LLC is indeed a true business. As with anything tax related it is always best to consult with a Certified Public Account or other tax professional who specializes in helping small businesses.

Final Thoughts on LLC

An LLC is a valuable means of protecting your personal assets from potential legal liabilities of your business. While you may do everything perfectly with regards to your business, that does not mean someone won’t come along and sue you. Having an LLC set up to run your business with helps ensures that you have extra protection and limits the risk that your personal assets could be used to pay for damages arising out of a lawsuit. To determine if an LLC is best for you talk to a local business planning attorney or corporate attorney in your area.

Do you need an LLC or have more questions about forming an LLC?

Paul Sian is a licensed attorney in the States of Ohio and Michigan.  If you have any questions on forming an LLC, have questions about running your business, or have some business related legal questions feel free to contact me at [email protected] or via phone at 513-943-5668.