Limited Liability Examined for Business Entities (Part 1)
Being a business owner means that you are responsible for the actions of your business, which includes your employees' actions under certain circumstances. However, in Massachusetts, there are a number of ways that the choice of entity type for your business may limit your personal risk. Usually the myriad of letters after a company name represents the level or degree of liability that a business (or rather its owners) is exposed to. We will look at these entity types in two separate posts. First, we will look into the Sole Proprietorship and different types of Partnerships. Then we will look at the Limited Liability Company and the Corporation.
However, one thing to ALWAYS remember - none of these business entity-types can eliminate the personal liability of a business owner (or director, officer, employee, etc.) for the torts that individual commits, even when acting in the course of the business. For example, where a business owner is driving a company car and hits and severely injures a pedestrian, the pedestrian can sue both the business and the business owner, and go after the business owner's personal assets to satisfy a judgment. So, where registering your business entity may protect you from the business debts of the business or limit your tax liability, you are not personally protected against torts that you commit, even when acting in the course of the business. This is often misunderstood, and is a major reason why purchasing liability insurance and umbrella policies is so important and strongly advised.
Sole Proprietorship: This is a business with one owner. He or she is the ultimate decision maker and business manager and as such is responsible for the actions of the business and its employees. This is a very inexpensive entity type because taxes are calculated based on the owner's personal income tax liability, there is limited government involvement, and no entity excise tax to operate such a business. The disadvantage of this entity type is that liability for the actions of the business and its employees, as well as business debts and contracts, falls on the owner. In other words, the owner has direct, personal liability. If another individual or business obtains a court judgment for money damages against the business, a court can enforce that judgment against the business owner's personal property, like his/her house, car and personal bank accounts. While a Sole Proprietor may avoid state filings and fees, corporate maintenance obligations, and business attorney's fees, there is no limited liability protection of the owners' personal assets. Organizing a separate and independent legal entity will save entrepreneurs / incorporators money in the long-term and protect the owners' hard-earned assets.
General Partnership: The General Partnership involves some of the same governing principles as the Sole Proprietorship, however there must be two or more owners. These owners share in the authority and liability of the business. There are tax benefits to a General Partnership and there is limited government involvement. Like in the Sole Proprietorship, a court can go after one or both of the partners' personal assets. The obvious disadvantage to operating your business as a General Partnership is that each partner is directly and personally liable for the acts and misdeeds of the other partners, not only his/her own. The General Partnership provides no limited liability protections to its partners. For this reason, there are few circumstances where it is advisable to operate a business as a General Partnership.
Limited Partnership (LP): This type of entity is usually used by professional services businesses such as accounting or law firms. There is usually a hierarchy within the structure of partners. There must be at least one "General Partner" (GP). The GP has direct and personal liability for the entire Limited Partnership. He/she is also the one with the most authority and managerial power. The other partners in this organization are called "Limited Partners" (LP). The LP has minimal or no decision-making authority. The liability of an LP is limited to the amount of funds or investment he/she injects into the business. However, one important note, is that if it is determined that the structure of the LP was created as a sham or fraud, all partners may be held directly and personally liable.
Limited Liability Partnership (LLP): This entity type limits the personal liability of a single partner for debts, obligations and liabilities of the partnership, whether in tort contract or otherwise from negligence, wrongful acts, errors or omissions, to what the partner 'invested' in the entity. However, a partner cannot eliminate liability for his own negligence. Every LLP is required to file an annual report with the Secretary of the Commonwealth of Massachusetts. One other thing to note is that the taxation of LLPs in Massachusetts does not depend on an LLP's federal tax classification. LLPs are taxed as partnerships under Massachusetts General Laws Ch. 62, sec. 17.
Limited Liability Company (LLC): LLC members are not personally liable for the LLC's debts, obligations and liabilities. Each members' liability is limited to whatever assets each has 'invested' in the entity. Each members can also participate in management and control of the LLC without increasing their personal liability exposure beyond their contribution to the entity. LLC in Massachusetts (and organized under the laws of Massachusetts) must have two or more members at the time of formation and at all times thereafter. An LLC can elect pass through tax treatment as a partnership for federal income tax purposes, while also maintaining the limited liability of its owners (called members).
One thing to recognize is that, in general, the greater the protection from liability an entity has, the greater the government supervision or involvement in the entity's organization. Once created, some of the most important things a business should do to protect its owners from liability is 1) obtain insurance (for hazards and director/officer liability insurance), 2) implement policies that set standards of conduct for employees and executives, 3) do not commingle assets, accounts, funds, or other property between the entity and any owner/member/partner, and 4) maintain proper records.
When starting or maintaining a business, it is always a smart idea to obtain legal advice. As always, an experienced attorney at THE JACOBS LAW LLC can help you with the creation of a business or help draft conduct and record-keeping policies for business maintenance. We can also help you convert your business into any entity type that fits your needs. If you have any questions or concerns, please feel free to contact THE JACOBS LAW LLC at [email protected] (mailto:[email protected]) .