I’ve heard that contractors should do business as an LLC so they can’t be sued. Is that true?
A conversation I had earlier this month answers the question.
But first, let’s define some terms. Members of an LLC (limited liability company) get the advantage of limited liability (like a corporation) but have the option of paying tax as either a partnership or a corporation. The IRS considers a single-member LLC to be the same as the owner for tax purposes but a separate company for employment purposes. The cost of setting up an LLC to comply with law in your state will be at least several hundred dollars for filing and recording forms. Plus, most states charge LLCs a minimum franchise tax. In California that’s $800 a year plus a fee on gross revenue that adds another $900 for up to $500,000 in income.
Question: So what do I get for all that trouble and expense?
Answer: Most important is what you don’t get.
- Debt relief? Not hardly. There’s no practical way to shift personal debt to an LLC.
- Easier to borrow money? Not likely. Lenders and credit card companies want a personal guarantee before extending credit to an LLC.
- Protection from liability for your negligence? Almost certainly not. You’ll be personally liable for your negligence, malpractice and errors committed while working for the LLC.
- A place to hide assets from creditors? No way. Nearly all states allow creditors to claim an owner’s interest in an LLC, either with a charging order or foreclosure or by having the LLC dissolved.
Question: But can’t I use the LLC name on all my contracts? That way, unhappy clients can’t sue me. They have to sue my LLC.
Answer: It’s not that simple! First, where contractors are licensed or registered, the name on a contract usually has to be the name on file with the state board. To understand what your state requires, get Construction Contract Writer. The trial version is free.
But suppose both your state and your clients are OK with the LLC alone listed as the construction contractor. Are your assets protected? Not necessarily. Courts routinely “pierce the corporate veil” of both LLCs and corporations to find an owner personally liable for company debts. A case decided last month in Alabama makes the point.
In March of 2013, Deann Fialkowski decided to put new shutters, doors, exterior siding and a raised deck on her home in Huntsville. Bruce Kitchura, supervisor for TLIG Maintenance, agreed to do the work. By December, Bruce had been paid nearly $38,000 but was in trouble with the building inspector. Work wasn’t being done according to code. Neither Bruce nor TLIG had a homebuilder’s license. The license TLIG had didn’t allow contracts for over $10,000. Deann told Bruce he could not "continue to build the way it is." Bruce asked Deann for more money to finish the work. She refused and Bruce walked off the job. Deann had others complete the work at a cost of $23,247.69 and filed suit against Bruce, TLIG and Bruce’s girlfriend, Gala P. Rusich, the only officer and stockholder in TLIG. Bruce was the sole employee.
The court of appeals found both TLIG and Gala liable for Deann’s loss, and for good reasons. Courts ignore shell companies that exist in name only. A company that isn’t keeping books and records isn’t really a company at all.
In the case of TLIG, Deann’s payments were deposited in the company account. So far, so good. But, according to Bruce, the only limit Gala put on use of TLIG money was "common sense things" like gambling or going to strip clubs, "things that would just be outrageously stupid." Bruce and Gala spent TLIG money at Dillard's and TJ Maxx, for medical prescriptions, haircuts, groceries, at bars and restaurants, trips to the Jack Daniel's Distillery in Kentucky and to Bruce’s family in Pennsylvania. Gala got new tires for her Mercedes paid for by TLIG. With all those expenses, TLIG didn’t have money left to finish Deann’s project.
The appellate court found both TLIG and Gala liable for Deann’s loss. The court’s decision was unanimous except for a dissent by Judge Moore. He would have found Bruce liable as well as Gala and TLIG.
Conclusion: Forming the corporation didn’t do Gala any good at all. The court's decision would have been the same whether TLIG was a corporation or an LLC. Neither would protect Gala from personal liability for TLIG debts given her business practice.
My advice: There’s no advantage in setting up your own corporation or LLC unless you’re willing to pay the extra fees, do the extra paperwork and separate company funds from personal funds. Until that day comes, there’s nothing wrong with writing contracts in your own name.