Are you a blogger? Do you own and rent out real estate or a vacation condo? Do you have a side gig?
If you answered yes to any of these questions, how well are you protecting yourself from liability issues – and at what cost? How are you documenting the things you are claiming on your tax return as a business expense?
Self employment is full of ripples and kinks, but I think the worst of them is the possibility that someone could come after your personal assets: your bank account, your house, your salary.
The next worst ripple to me is the possibility that the IRS will decide to audit you because of your business activity, and the way you claim deductions on your tax filings.
Keeping business and personal transactions separate is key to avoiding issues in both areas. One way to do so is to set up a limited liability corporation (llc).
Most of you are probably aware that an llc is a separate entity in the eyes of the law. Many of you are aware that having your business activity done under the wing of your llc can help you avoid personal liability for legal issues. However, for that to work, you have to avoid the possibility of someone ‘piercing your corporate veil’.
How to reduce chances of your llc corporate veil being pierced.
Things you could do to get sued!
Maybe you got carried away in a blog post and recommended a particular stock. Someone out there read your recommendation, bought it and lost the farm. Now they want you to pay up because ‘you told them to buy it’. Perhaps that wonderful renter in your little rental house pays their rent every month, but then, they slip in the bathtub, break a leg and can’t work for months. Now they are suing you because you didn’t have a non-slip mat in the tub! They want your rental house, your home, and your vacation condo as compensation!
Perhaps you write code on the side for a buddy who is free lancing for other clients. What if your code malfunctions and your buddy turns on you to make up the damages he is suffering due to a lawsuit on a faulty product?
What happens if you get sued under an llc?
It is my non-professional understanding that if you operate your business as an llc, and it is sued, the person suing you can only go after your business assets. When the business assets are gone, they are done. However, this is only true if the court decides not to pierce the corporate veil. If the veil is pierced, the claimant can and probably will come after your personal assets to the full extent of the law. Of course, if you are in this situation, seek legal help specific to you.
How do you keep your corporate veil intact?
According to NOLO the courts are more likely to pierce the veil of a small or closely held corporation. That is why we should be extra vigilant about following the legal requirements in our states pertaining to llcs and also follow the best business practices of keeping business and personal accounts and records separate (and complete).
The veil can be punctured if a) there is no real separation between the company and the owners, b) the company’s actions were wrongful or fraudulent, AND, c) your company’s creditors had unjust costs. According to NOLO, all of these must be true.
So, set up a separate business bank account, and DON’T write a check out of it for a personal purchase. Don’t deposit business funds into your personal account. Look up and follow all of the state law mandated reporting (if any) and other procedures required for llcs in your state. Hold an annual meeting and document it (print out those minutes, have members sign them, document decisions made and etc). Keep separate records in your accounting software or whatever tools you use for record keeping. Keep them organized, keep them up to date.
In fact NOLO recomends all of the below in addition to what was just stated:
- Make a reasonable initial investment in the corporation or LLC so that it is adequately capitalized.
- Don’t tell a creditor that you will personally guarantee payment of the corporation or LLC’s debts.
- Don’t use the corporation or LLC to engage in illegal, fraudulent, or reckless acts.
- Make sure the world knows it is dealing with a corporation or LLC by conspicuously identifying the company status (that is, “Inc.” or “LLC”) on all business cards, letters, quotes, invoices, statements, directory listings, advertisements, and all other forms of company communication. When signing company documents, clearly state your representative capacity (such as, “Jane Doe, President, Acme LLC.”)
Keeping your business and personal activities separated will also help you at tax time (and audit time should that happen). According to an April 2012 Forbes article, the IRS is targeting smaller businesses for audits.
The IRS believes that the benefits to keeping your business records up to date include allowing you to monitor business progress; helping you prepare financial statements; knowing the source of income and helping you keep track of things you can deduct. Having the records organized and up to date can help you save time when your return is prepared as well as support those deductions you want so badly to claim.
One of those deductions might be a home office. For many years, work at home folks have been scared to claim this deduction because they thought it might trigger an audit, apparently, they are correct. According to this story in Entrepreneur online.
“Salmen shared the story of one of his clients. The wife was a salaried employee and the husband ran money-losing photography business out of a home office. He was eligible for the home office deduction, but because his business lost money, Salmen warned it might be a red flag for an audit.
They took photos of the office, which was used solely for business, and after the audit, they were able to keep the home office deductions.”
They kept the area just for a home office, and they could prove it!
I have two limited liability corporations, one for our vacation condo (which is in the nightly rental program); and one for my online businesses. One is a partnership with my spouse and the other is a single member llc. Single member llc’s are even more at risk for breaking the corporate veil. I have separate bank accounts for each company, keep separate and up to date records, including copies of all income and expense receipts and statements; never mix assets between the two businesses or between each business and our personal assets. I hold meetings with my spouse and myself annually, type up and print and sign the minutes and otherwise try my best to keep my veil in place! Sometimes it is a pain, but it helps me sleep at night! We also have liability insurance on the condo, due to it being a physical place and because we have renters in there.
What do you do to protect yourself and your business from audits and litigants?
My name is Derek, and I have my Bachelors Degree in Finance from Grand Valley State University. After graduation, I was not able to find a job that fully utilized my degree, but I still had a passion for Finance! So, I decided to focus my passion in the stock market. I studied Cash Flows, Balance Sheets, and Income Statements, put some money into the market and saw a good return on my investment. As satisfying as this was, I still felt that something was missing. I have a passion for Finance, but I also have a passion for people. If you have a willingness to learn, I will continue to teach.