Whenever I see someone pose a legal or tax question on a Facebook group, I take a moment to breathe deeply before I begin reading the inevitable dumpster fire of answers below. I get it. Everyone wants to be helpful. It feels nice to provide valuable insight. It’s just problematic when that insight is not grounded in expertise, or at least in a basic understanding of the issue.
I don’t have time to police the internet for garbage advice, so instead, I have compiled this list of the worst pieces of legal advice I have found in Facebook groups in hopes that, at a minimum, it will make you second guess what information you request and believe on social media.
1) “I know LLCs help protect you, but why do you need one if you have a super great contract that covers everything.”
So this one was a question, but I still thought it’d be worth sharing.
Contracts are awesome. I love em. Can’t get enough of em. They’re bitchin, but they shouldn’t thought of as the moat to your castle (the castle being your business). Sure, you can limit liability with things like indemnity – a concept I won’t fully bore you with here – provisions and such, but ultimately a contract is to help iron out the understanding between the parties on the services or goods to be provided. They are not there to protect your ass from bullshit lawsuits. Sorry for all the swears. I have had a lot of coffee and am feeling VERY HYPED. If we want to continue the castle analogy, think of your contract as diplomacy done through treaties. It’s preventative in nature but does help clarify how certain issues will be handled should they come up. The moat would be more like an LLC.
2) Asking about converting an LLC to a Sole Proprietorship
I found one question for a business owner who wanted to convert their LLC back into a sole proprietorship to save taxes. Immediately, I thought that was odd, so I was curious what their reasoning was. The person had commented that the business wasn’t making much money, so it wasn’t worth paying the taxes on an LLC. What many people don’t know is that an LLC is a “pass-through entity.” The income to the business passes through the business to the individual. What does this mean? The income ends up on your personal tax return. As such, an LLC has 0 effect on your income taxes. You do have to pay an annual franchise tax in some states to have an LLC. In California, it’s $800. In most other states, the amount ranges from $0 to $300. I explain this as a fee to have the LLC. It’s more like an annual fee and less of a tax. The taxpayer who had asked this question believed that going back to a sole proprietorship would prevent needing to pay “business taxes.” That’s not the case.
3) Stick with a sole proprietorship because it gives you “more wiggle room with how you can invest in your business.”
Umm. Not really. This person specifically said that it’s better for the home office and storage deductions. If you are a solo business owner, your income and expenses go onto the exact same tax form when you file your taxes as they would if you converted to an LLC. It’s the same thing. These rules do get more complex if you have an s corp or have an LLC with a business partner, so there may have been a basis of truth and understanding to the blanket advice provided.
4) “My tax person told me not to worry about forming an LLC until I’m making more than $8,000 per year because the LLC fees don’t make sense until I hit that threshold.”
Arrrgh. $8,000 is so arbitrary and doesn’t make sense. Here’s a super extreme example. Bill Gates decides to start a base-jumping business. When people ask “is this safe?” He response is “probably.” That’s terrifying, so only one person pays to base jump. He breaks a leg. Bill Gates makes $0 in his base-jumping business. If I’m that guy’s attorney, you can bet your ass we will sue for medical bills, emotional distress, and whatever else we can. The amount of Mr. Gates made or didn’t make in the business is totally irrelevant.
What I’m assuming the tax pro was actually explaining to this person is that the less you make, the fewer clients you have, and the fewer clients you have, the less likely you are to have an issue. Why they threw out $8,000 I have no idea.
Also consider your business model. Most of us are not involved in something as risky as base jumping. However, here’s a better example. You open an event venue. On day one, someone falls down the stairs. 6-months later you get a demand letter from an attorney asking for $50,000 to cover pain and suffering. The LLC separates you from your business and helps protect your personal assets from a judgement sought to satisfy any damages awarded in a lawsuit.The DBA
5) Don’t get an LLC until you have employees
Noooo. See all the examples above. Also, another common issue is misclassification. If a former independent contractor files a suit against you claiming that they should have been an employee, you will want an LLC. It is true that having employees and contractors increase your liability. Thus, you definitely will want an entity to protect you once you start hiring, but it’s most likely still a good idea to form one before.
6) Before deciding if you need an LLC call your tax person/CPA/tax pro
Ok, this isn’t awful advice but it’s a pet peeve of mine. The point I want to make is that tax pros are there to give you tax advice. It’s one factor in determining your business structure. As I noted above, converting to an LLC has no impact on your income taxes. Over and over again I see in Facebook groups people stating that their tax professional told them there was no reason to get an LLC.
What they don’t realize is that the tax person is not an attorney. They are not advising on risk or legal structure. Also, when you are ready to form an LLC, you will need an operating agreement which is a legal document that should be prepared by a licensed attorney.
I advise pretty much anyone netting less than $50,000 in their business to form an LLC. If you’re above that threshold, then there are other options, like an s corp, that may save you on taxes. In that case, you should absolutely talk to a tax professional, but you will still want to use an attorney to form the entity. Also, I need to give the caveat that things are more complex in partnerships. There are definitely tax concerns if you’re contributing cash or property into the business and you need a good attorney and tax person even if you plan to take years to reach profitability.
7) You can’t get sued if you have an LLC
Wrong. You absolutely can. Clients and customers and vendors and whoever can sue you. Typically, with the LLC the difference is that they’re only going to be able to lay their hands on your business assets to settle the suit. Of course, there are exceptions to this as well.
If you comingle your funds, don’t abide by the formalities required of LLCs (having an operating agreement, separate bank account, etc.) then a plaintiff may be able to go after your personal assets. This is another reason to work with an attorney to set up your LLC properly. Also, if you commit fraud. Don’t commit fraud. Your entity won’t protect you.
8) If you’re in an LLC with a business partner, the LLC will pay the taxes and after that, you will be required to pay personal income tax. This is why a single member LLC is better.
No. Wrong. LLCs are still generally pass-through entities, which means the entity does not pay tax. Here’s how it actually works.
Assume Betty and Sue are business partners with an LLC. They have not filed an s election, so they are taxed under the normal, default rules of a partnership. They brought in $100,000 in 2018 and had business expenses of $20,000. They are 50/50 partners in the business for all purposes.
Betty and Sue need to file a IRS Form 1065, which is a partnership tax return. On that document, they report their income and expenses. Since they’re 50/50 partners, everything is divided in half and they both end up reporting $50,000 in income and $10,000 in expenses on their personal returns. The outcome is exactly the same as if they had both had their own businesses bringing in half of what they did as partners.
9) An LLC is a corporation. It’s required to have more than one partner.
This is the opposite of true. A corporation is a corporation. An LLC is an LLC. Those are two different things. You can have a LLC with one owner, we call this a single member LLC or with two owners, a multi-member LLC. Corporations can also have one or multiple owners.
10) Form your LLC is ___ state because it’s better.
This is a super loaded answer. In some cases, you may want to form in a specific state, but most often you will want to form wherever you’re operating your business. I have an entire blog on this topic, so if you want more info on this one, check it out.
The lessons to be learned:
Many people may get correct advice based on their business structure but they then generalize it to everyone. If you’re ever reading through a social media thread where people are provided legal and tax guidance consider that the advice was likely specific to their business, state, or industry.