Everyone who has ever run a small business knows that it is a risky proposition, but the risk should be to the business, not to the individuals involved. To that end, one of the most important things to consider when forming a business is how to shield the owners from being personally liable for the debts of the business, including tax debts.
The best time to address this issue is early on, during the business formation process. The business structure one chooses has profound implications for liability.
Business formation
The simplest type of business is a sole proprietorship, but its simplicity makes it potentially dangerous for the owner’s personal finances. In the eyes of the law, there is no separation between the assets and liabilities of the business and those of the owner. If the business gets into tax trouble, the IRS can demand payment from the owner.
A partnership is slightly more complex than a sole proprietorship, but still the law treats the finances of the owners the same as the finances of the business.
This is in marked contrast to how the law treats corporations, in which there is a clear separation between the business’ debts and those of the shareholders and executives involved. If the corporation gets in deep tax trouble, investors may lose their investment in the corporation, but generally the IRS won’t seize their personal savings. However, most smaller businesses do not need a structure as complex as that of a corporation.
The LLC
A Limited Liability Company, or LLC, is often the most appropriate structure for a small business. As the name implies, an LLC places limits on the amount of liability the owner can hold for the business’ debts.
There are different types of LLCs, but generally these businesses split the difference between corporations and sole proprietorships. The income of the LLC may be taxed out of the owners’ personal income, but owners are not entirely personally liable for the debts and obligations of the business. As with a corporation, they may lose their personal investments into the business, but the IRS won’t seize their kids’ college funds.
Those starting a new business should consult with a lawyer who has experience in tax and business law.