If you are a lawyer, doctor, or accountant starting your own practice, one of the earliest decisions you will need to make is the type of business entity you would like to form. There are the well-known traditional options, such as incorporating. But those tend to be expensive and to require too many formalities for small operations. Better options exist for small business professional service providers, most notably the professional corporation and the limited liability company. But having just been through this myself, I know that choosing between a PC and an LLC as your business form can be confusing.
Factors to consider when choosing between a PC and an LLC
A professional corporation and a limited liability company both offer their owners the benefit of limited liability in the event that an activity of the business harms someone. For professionals, however, this liability limitation does not extend to our biggest risk — being sued by a client or patient for malpractice. A professional corporation, however, will protect you from liability for the malpractice of your partners, if you have them. And a limited liability company will limit your liability from other sources of risk. For instance, if you get into a dispute with your landlord, your liability to your landlord might be limited.
When choosing between a PC and an LLC, the determining factor may be how you want to handle your taxes. Creating a single member LLC will have a minimal impact on your taxes. All that is required is an extra attachment to your personal tax returns. PCs can also be set up as pass-through entities. The default, however, is that PCs are required to file their own tax returns and be subject to corporate tax rates, which are notoriously high.
If you are going to be working alone, without partners, I see few benefits to establishing a PC as opposed to an LLC. Whichever route you decide to go, you will need to confirm that the option you choose is recognized by all the states in which you intend to operate. Both PCs and LLCs are created by state legislation, and the rules for establishing and operating them can therefore vary from state to state.
Do you really need to form an entity?
One other question you should ask yourself — perhaps the first question — is whether you need a formal entity at all, or whether you can get by operating as a sole proprietorship. As this post notes, once you create a PC or an LLC, there are certain, sometimes burdensome bookkeeping and paperwork formalities that you must observe to actually enjoy the benefits of limited liability. Moreover, there are fees that you will have to pay to your state’s secretary of state every year to keep your business records current. And as noted above, unlike other businesses, professionals subject to malpractice lawsuits cannot limit their professional liability by shielding themselves with a business entity.
What this all means is that there are fewer benefits to a professional business of creating a limited liability entity than there are for other types of businesses. Yet the burdens and costs are exactly the same. Still, there are several good reasons to use a limited liability entity. First, although it is true that professional services cannot use business entities to limit their malpractice liability, malpractice liability is not the only type of risk your business will face. For instance, assuming that you are fortunate enough to have clients or patients regularly coming into your business, there’s a risk that one of them will suffer an injury while on your property and hold you and maybe your landlord liable. You should insure yourself against that risk (your landlord will probably require it), and when you do, your insurer might consider it a positive if your business has a limited liability structure.
Second, although you might not need limited liability protection now, if your business grows, as you’re probably hoping it will, your need for a limited liability structure will increase. Changing to a different structure later on will at least be inconvenient, if not extremely costly. At the minimum, you will have to change your letterhead, your business cards, your website, the name on your checks, and maybe the sign on your door. Many of the formalities that you would need to observe while running a limited liability entity, such as maintaining separate books and accounts, are things you’re going to want to do anyway, even if you are running a sole proprietorship. Avoiding the hassle of having to make a change later on might be worth dealing with the hassles of observing some of these formalities now.
If you are a Colorado business thinking through entity formation issues such as these, please call me with any questions that you have about the process, and the benefits and costs associated with your various options.