Limited Liability Entities
A guide for small firm owners.
"I don’t have any personal liability risk
for the work I do because I operate my
firm as a limited liability company.” We hear this often from professionals
like right of way agents and appraisers
who have started their own firms.
Unfortunately, this is an incorrect
understanding of the legal protections
provided by organizing a firm as a
limited liability type of business entity.
The most common forms of
limited liability business entities
are corporations, limited liability
companies (LLCs) and limited liability
partnerships (LLPs). Whether your
firm provides right of way, appraisal
or other property-related services,
choosing to organize your business in
one of these forms definitely can be
a smart business move. Nevertheless,
the legal reality is that corporations,
LLCs and LLPs don’t actually protect
the professionals working in the firms
from potential liability for claims
about their own alleged professional
errors and omissions. The easiest way
to comprehend this legal conclusion is
by thinking about a more commonly
discussed area of professional liability:
medical malpractice. When a doctor
makes a bad mistake in treating a
patient and the patient’s lawyer pursues
legal action, the lawsuit almost always
will name the doctor as an individual
defendant (as well as other parties,
like the hospital).
Whether it’s a doctor, appraiser or
right of way agent, the individual
professional who performs the
work has primary responsibility
and potential legal liability for their
own work. The firm itself also has
potential liability risk for the work,
but that liability stems vicariously
from the staff member who actually
performs the service. This is why
in professional negligence lawsuits
stemming from deficient right of way
or appraisal work, we commonly see
both the individual professionals
who performed the work and the
firm named as defendants. The cold
truth that professionals don’t escape
liability for their own work, however,
doesn’t mean that owners of firms
should avoid organizing their firms
as limited liability business entities.
Choosing the right entity form
still offers plenty of other liability
protections and additional benefits
besides protecting oneself from
professional liability. This is especially
the case for the owners of small firms,
as the largest of firms almost always
are already formed as corporate or
LLC entities.
Basic Business Entity Options
When considering the creation of a
new firm or a change in the form of an
existing firm, the principal business
entity options available are: sole
proprietorships, general partnerships,
corporations, LLCs and limited liability
partnerships. Let’s take a look at each
type of entity and at some of the key
reasons why you might choose one over
another as a right of way professional.
Sole Proprietorships and General
Partnerships. If you’re going into
business for yourself— either alone or
with colleagues—sole proprietorships
and general partnerships are the
easiest types of business entities to
form. That's because they are formed
by default if you don't take the official
steps to create a different type of
business entity. If you start a business
alone, you'll have sole proprietorship
by default. Similarly, in most states,
if you start doing business with
a colleague or several colleagues
and do nothing to form a separate
legal entity with them, the law will
presume that you have a general
partnership, with each of your owner colleagues
being a partner. These
are the default forms of business.
The downside is that they provide absolutely zero liability protection.
For example, if three appraisers are
working together and haven’t formed
a different type of entity, they will
each be personally liable not only
for their own professional work, but
also personally at risk for the work
of the two other partners—even for
valuation errors by another partner.
Moreover, they will each have full
personal liability for all of the other
non-professional debts and liabilities
of their business. For example, if they
lease an office together in the name of
their partnership, they are each liable
for lease obligations. If one of their
administrative employees suffers an
injury at the office, they may each face
potential personal liability.
Despite the lack of protection, a
sole-proprietor form of business may
still be acceptable for a solo operator
with no other professional employees
performing services in the name of
the firm and/or no other significant
staff. This form of business is simple
and inexpensive because it has no
state registration requirements.
Because a solo practitioner is
potentially liable for their own
professional errors anyway, there
is less to gain in this scenario from
using a limited liability entity unless
the firm is exposed to significant
non-professional risks or liabilities.
For income tax purposes, it’s also
an easy entity to report because the
income from your sole-proprietorship
is simply reported on a Schedule C
to your regular personal income tax
return; no separate tax return is filed
for the business.
However, when the solo operator
starts taking on employees who also
perform professional services, that’s
when the small firm owner should
consider one of the limited liability
entity types. Otherwise, in a scenario
involving a significant claim about a
professional employee’s work, the sole
proprietor may find him or herself
personally liable for that claim. It’s an
especially important consideration
because as the employer of the
professional staff member, the firm
and its sole proprietor likely have a legal duty to the employee to pay
the costs of defending the employee
for work on behalf of the firm and
paying any amount for which the
employee may be found liable.
Multiple professionals in business
together should also generally
look toward one of the limited
liability forms of business to protect
themselves against personal liability
for each other’s work or the work
of professional employees in the
firm. As a general rule, they should
not choose the default entity mode
which usually means a general
partnership. We have seen cases
where one partner was held liable
for the other partner’s work and
the innocent partner was forced
to pay up because the responsible
partner’s assets could not satisfy the
judgment.
Corporations. Corporations are
the traditional form of business
that people think of when it comes
to limiting liability. One frequent
misunderstanding, however, is
confusion between so-called “C
corporations” (or “C-corps”)
and “S-corps.” Although some
states do have special statutes for
corporations with a small number
of shareholders, the terms C-corp
and S-corp specifically pertain to
federal taxation chapters in the
Internal Revenue Code. The choice
between a C-corp or an S-corp deals
with tax reporting purposes and
does not relate to the organizational
formalities of the corporation. With
C-corps, a separate income tax is
levied at the corporate level; while
with an S-corp, the income is tallied
at the corporate level but then
flows through to each shareholder
with all income taxes paid at the
individual shareholder level. For tax
purposes, the owners of relatively
small right of way or appraisal firms
will usually elect to be considered
S-corps to avoid the double taxation
imposed on C-corps. However, this
is a matter to consult with your
accountant because of the tax law
changes taking effect for the 2018
tax year.
Regardless of the tax treatment
elected by shareholders,
corporations share the big advantage
of limiting the personal liability of
their owners. With a corporation,
the shareholders are not personally
liable for the debts and liabilities
of the corporation, subject to some
exceptions pertaining to piercing of
the corporate veil.
Limited Liability Companies. Like
corporations, LLCs also protect
their owners—technically referred
to as members—from personal
liability for the debts/liabilities of
the business. Thus, when an LLC
is owned by multiple professional
members, none of the members
will have personal liability for the
professional errors or omissions
of the other members. And for tax
purposes, the LLC’s income flows
through to its owners without
separate taxation at the entity level.
Furthermore, when an LLC is owned
by a single member, that single
member can even choose to report
the LLC-earned income on a simple
Schedule C, rather than preparing a
separate return for the LLC.
Another key benefit to the LLC
form is that the official paperwork
required for operating LLCs
under most state laws is generally
reduced. For the most part, official
meetings, minutes, resolutions and
a lot of the regular administrative
recordkeeping required for
corporations are eliminated. This
is one of the key reasons that many
small firm owners choose the LLC
form.
Limited Liability Partnerships.
Limited liability partnerships
(LLPs) are a relatively new business
entity form in many states. Like
corporations and LLCs, LLPs
can only be created by formal
registration with the state. Under
most states’ laws, they also provide
liability protection in that partners
are not ordinarily liable for the
negligence of another partner.
Though the details will vary from
state to state, there is often no personal liability protection for
contractual (non-professional)
liabilities of the partnership.
Choosing to Form a Limited Liability Entity
If the discussion in this article has
moved you to consider organizing a new
small firm or reorganizing an existing
small firm as a limited liability entity, it
is highly recommended that you seek
two forms of advice:
- Accounting advice to help you select the most tax appropriate entity applicable to your circumstances and
- Legal advice from an attorney with experience helping small businesses.
The outline of tax matters in this article
is greatly simplified and there are
additional entity choices available in
some states which may provide more
benefits or come at lower regulatory
cost. Accounting and legal advice for
making good choices are not expensive
services to retain, and doing it right
from the beginning will save thousands
of dollars in later professional fees to redo
incorrect choices and/or unnecessary
taxes.
Preserving the Liability Protection of Your Entity
Corporations, LLCs and LLPs can
provide excellent protection, but like
most operating things, there’s some
maintenance involved. The principal
way that liability protection can be lost
is if a creditor is able to “pierce the veil”
of the entity. Based on claims we’ve seen
involving right of way and appraisal
firm owners, the key details to handle
correctly are:
- Respect the administrative
requirements of the business form
you’ve chosen. If it’s an LLC, this
will usually mean filing annual
registration statements in your state
and filing required tax returns. If it’s
a corporation, there will be more formalities involved and you’ll likely
need some guidance as to the proper
keeping of minutes and preparation
of appropriate documentation
regarding key decisions.
- Do not commingle the funds of
any business entity with personal
funds. Do not use the business bank
account to pay personal bills. Pay
yourself first, document it in your
accounting and then pay your bills
from your personal account.
- Sign all documents on behalf of
the firm and in the name of the
firm. For example, when using an
engagement agreement for an LLC
firm, always make sure that the
agreement includes the full name
of the firm at the beginning of the
agreement and that the identification
of the firm lists it as a limited liability
company, either by including those
words or using the LLC abbreviation.
Sign the agreement with a reference
to your working title and include the
name of the firm in the signature
block.
In Summary
Small firm owners can greatly benefit
from gaining an understanding of the
various elements involved in each limited
liability entity. While there are advantages
and disadvantages related to each type
of entity, determining what best protects
yourself, your staff, your clients and your
company will be vital when matters of
liability come into play. Good luck with
your business!
This article originally appeared in, and is reprinted from, The Right of Way Magazine (September/October 2018). © 2018 by International Right of Way Association, Gardena, CA . Archives of Right of Way magazine, including Peter's past columns, are available at https://www.irwaonline.org/members/publications/archives-2015-present/