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February 21, 2012

3

To LLC or not to LLC? That is the Question (Part 1)

I was recently asked about how to start up a LLC.  A friend is thinking about investing and is curious about how to set one up.  I figured I’d share my thoughts on the subject and relate my experiences as the sole member of Bag of Holdings, LLC.

*Disclaimer:  I am not a lawyer or tax professional.  It would be foolish to do anything based solely on what I have to say about the subject.  Also, my experience has to do with a single-member LLC.  There are other configurations that may be more useful to you (LLP, S-corp, C-corp.)  I may talk about those at a later date, but not on this day.

Before getting into HOW to start a LLC, a more important question is “SHOULD I start one?”  The best way to determine that is to look at what an LLC does and doesn’t do.

  • A LLC does provide personal asset protection.  If you are starting a business, a LLC gives you a solid demarcation between your business assets and your personal assets.  If something goes wrong with your business or it gets in trouble for whatever reason, only the assets held by the LLC can be attached.  Your personal assets cannot be used.  For example, let’s say you own a deli through a LLC.  If someone gets food poisoning from your egg salad sandwich and dies, their survivors can sue the deli and will probably take all of the assets held by the deli.  But they can’t take your personal assets like your car, home, retirement fund, etc.  If you own that deli as a sole proprietor, then everything you own is fair game.
  • A LLC does provide flexibility.  When I first started Bag of Holdings, all I was prepared to do with it was invest.  I knew I was going to branch out sooner or later, even if I didn’t know what that was going to look like.  With BoH, I have an infrastructure set up to support this diversification.  For example, I just published an iPhone app and I have another one in development.  I have a very modest affiliate income through the websites I currently publish.  I have dividends through my stock portfolio.  I do occasional consulting work for iOS apps.  I am also working on a real estate investment that should provide a modest return.  It’s nice to have a single bucket to pour my different income streams.
  • A LLC does NOT provide complete asset protection.  When I was researching creating a LLC, I came across countless stories of people who use their LLC as a haven for personal assets.  Everything was paid for out of LLC funds and everything they “owned” was in the LLC’s name.  Many people were also under the impression that if they got sued personally, the LLC would protect their assets.  I did some more checking and found out that this is not the case.  The asset protection is only one way.  The LLC protects your personal assets from your business, it doesn’t protect your business assets from you.  In the eyes of the law, your LLC is a personal asset.
  • A LLC does NOT provide special tax privileges.  A LLC is considered a pass-through entity when it comes to taxes.  That means whatever profit you make under your LLC is reported on your personal taxes.  If BoH makes $1,000.00 this year, I’ll have to report it as income above and beyond whatever my salary turns out to be and pay the taxes on it, even if I don’t withdraw a penny from the BoH bank account.  I’ve read about all kinds of ways that people have tried to use the LLC as a way to manage their taxes, from buying a computer through the LLC and leasing it back to themselves to leasing a car under in the LLC’s name so it can be written off.  I don’t recommend any of those of things.  First, no matter what anyone says or how long they get away with it, it smells less-than-legal and should be avoided.  Second, it introduces a whole level of complexity to something that you want to keep as simple as possible.  Don’t get me wrong, you will be able to write off legitimate business expenses like web hosting and design work.  It’s just not a good idea to get fancy about it.

Now, with all that in mind, should you create a LLC?

For my friend who wants to use a LLC just to buy securities, I’d advise against it.  Owning stock already has asset protection baked into it and it doesn’t provide a tax advantage over just having a brokerage account in your name.  Better to save the filing fees.

If you are starting a business or investing in something like real estate that doesn’t have built-in asset protection, it’s the first thing you should do.  Putting that wall between company assets and personal assets is essential.

If you’re looking to game the system, don’t.  Using a LLC to hide your personal assets and/or avoid taxes, no matter how clever you think you are, is a suckers game.  The IRS (or your soon to be ex-wife’s lawyer) is smarter than you and has a way bigger hammer.

Thanks for reading.  Questions, comments, criticisms, things I missed or am just wrong about, leave a comment.

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  1. Mar 16 2012

    Question on LLC formation; I have all my blogs under an LLC. If someone online doesn’t like something I say about their business or whatever, and they want to sue me for defamation or something else related to a blog post, I had previously assumed my LLC would protect my personal assets (since it was posted on my blog), but others have said it would provide no protection and I’d be sued personally. Thoughts?

    Reply
    • admin
      Mar 16 2012

      With the caveat that I’m not a legal professional, I would assume the situation is analogous to a reporter being sued because of an article he wrote. As far as I know, both the reporter and the paper would be on the hook for libelous claims. A reporter does not get legal protection against libel because they got paid for the content.

      That being said, not liking what someone wrote about you is very, very far from having an actionable claim of libel. First, I’d suggest doing some research on what constitutes libel and/or slander. A claim of libel has to meet a few conditions to be actionable. Second, with that knowledge in hand, be careful about what you say. Third, consult an attorney if you really think someone is serious about suing.

      Reply

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