Why Your Business Structure Matters

When forming or restructuring a business, business owners need to make sure that the business structure and how the business operates best protects the owner(s) from personal liability in the event of a lawsuit. There are several different types of businesses an owner can form when setting up a business or when restructuring a business. The types of business structures that do not provide an owner with personal liability protection are the sole proprietorship and the classical partnership. With those types of entities, there is no separate tax ID number that needs to be acquired for the business. For a sole proprietor, the business owner uses their individual social security number as the tax identifier to form and operate the business. Their individual social security number is also used to open their business bank account, and pay their taxes, making the owner personally liable for their business and its debts. 

A partnership operates the same way. The partners enter into a partnership agreement and use their social security numbers to register the business, open the business bank account, and pay the company taxes, making all of them personally liable for the business debts and obligations. In a broader sense, being personally responsible for the debts and obligations of the business means that if the business is sued and the claimant is successful with the lawsuit, then the claimant can go after the owners personally to satisfy the judgment.

The two most common entities that owners form to provide personal liability protection are the limited liability company (also referred to as an LLC) and the corporation. There are two primary types of corporations, an S Chapter Corporation (also referred to as an S Corp) and a C Chapter Corporation (also referred to as a C Corp). Not many individuals opt to start a C Corp, unless the owners plan on taking the corporation public (i.e. publicly listed on the stock market) at some point in the future. Most new businesses owners, if they have opted to start a corporation, will typically form S Corp, which is much easier to operate as a small business owner.

The corporation and the limited liability company will protect a business owner or owners personally from liability in the event of a lawsuit, as long as the owner is running the business properly. “Running the business properly” means is that the owner pays business expenses from their business bank account and pays personal expenses from their personal bank account. There should be no co-mingling of funds (i.e. paying business expenses from a personal bank account or paying personal expenses from a business bank account). Additionally, when an owner gets paid, the owner writes a check from the business account and deposits it in their personal bank account. It’s imperative to have two separate sets of financial books and records, both personal and business.

If a business owner co-mingles funds, by paying personal expenses out of a business account and vice versa, a business owner can become personally liable if someone sues the business and is successful in obtaining a judgment against the business. If the owner is co-mingling funds, the successful party that obtains a judgement against the business could pursue personal assets to satisfy the judgment. This is known as “piercing the veil”. This is why it is imperative that a business owner form their business properly in order to best protect themselves from personal liability.