Ann McAlhany is a small business advisor at the Maine Small Business Development Center in Bangor.
Sometimes we find ourselves in a business and realize that we got there without a lot of intentional planning. Maybe we eased into the business with someone else, or really started our operations as a hobby rather than a true profit-generating enterprise. Perhaps we inherited it from someone else, for instance. Or, just maybe, we thought planning decisions were too expensive … or not a big deal … or we were too busy. Then a time comes when it is important to step back and think about our operation as a business, as something intentional and apart from ourselves. Legal entity is a great place to start. So, who are you? It’s a question worth answering. The choice of “legal entity” is influenced by the dual considerations of business liability and tax implications. Basically, there are two choices for your business. Either you and the business are joined, or you have separated the business into a different entity.
Either you are a sole proprietor and you and your business finances are mushed together, or you have created a separate legal entity for your business. If you don’t do anything, you are, by default, a sole proprietor. In this case any liability in the business or your personal life can affect the other; they are not separated. That means, should there be an accident with your boat — the sun is in your eyes as you motor back to the wharf and you nick one of those kayaks slithering on the water. OOOPS! — then all your personal assets, all the things that you own, such as your house or your car or your motorcycle, could be in jeopardy. That is because you and the business are considered one. On the other hand, you can separate the business from your person by creating a separate legal entity. The most common are LLC (Limited Liability Company) or subchapter S-corporation. In either of these, you have separated the business from your personal affairs and therefore separated the liability.
Ok, so you want to form a legal entity, but you don’t know how and you worry that it will be awfully expensive. Yes, you can get the forms from the state (Maine Bureau of Corporations) and do it yourself for a couple hundred dollars. However, there might be questions you don’t know how to answer, or advantages to the various business structures that support your long-term goals that a lawyer would be best suited to help you navigate. To form a legal entity is a one-time expense (with annual renewals), and from my conversations with attorneys, a basic business formation costs about eight hundred to a thousand dollars. It may be well worth the extra cost to talk to someone who knows the ins and outs of the formation process. But remember, if your business is a separate entity, then you need to act like it is something separate. You should have a separate business bank account. All business bills get paid from the business account. All personal payments, such as your personal house mortgage payment or your ATV payment, are made from your personal bank account, and so forth. Sure, the business is there to make money for you, so you write yourself a business check or make a bank transfer to take an owners draw (or issue a paycheck to yourself, in the case of an S-Corp). But then, pay all your personal bills from your personal account.
If you continue to pay personal bills from the business side or vice versa, then that would be considered “piercing the corporate veil,” and you would have defeated the purpose of separating the business liability from yourself. Also, by separating the business transactions from your personal finances, you have a better opportunity to analyze the financials of the business and understand how the business is operating. This will allow you to make better and more informed business decisions. That has a lot to do with business recordkeeping… which will be an article for another time!
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