My background professionally has included twenty years of doing this (one decade in public accounting and private equity, a second decade with my own small business advisory practice that runs hand in hand with my work in network security. I am qualified to give this advice I strongly urge that anyone that is contemplating forming their own business entity to seek professional advice of a Certified Public Accountant (CPA) that works in the business advisory capacity or an attorney that is active in mitigating small business matters.
It is with full confidence the advice here is prudent, conservative and appropriate.
Scenario: You are currently a Yoga instructor, a construction contractor, a landscaper, a blogger even. You have found yourself in the gig economy. You have your own business operation.
To some it seems exotic to incorporate/form a formal legal business entity – a Limited Liability Company, LLC, or a Corporation. Some do not consider it entirely, for good reason too. Your livelihood is as a tradesman, not someone who deals with back end, bureaucratic filing of paperwork.
It is with my own business acumen that I apply this philosophy when I gauge a scenario a client is facing: What is the worst case scenario for this business? And what must be done to safeguard against the fallout from the realization of a worst case scenario?
The reason I advise clients that have their own business operations underway in the form of a sole proprietorship, to organize a bona fide business entity, is for that worst case scenario. This is done in order to insolate and isolate yourself, the person, from your business activities, the business operation, to the furthest extent available. The worst case scenario you face is being sued. All businesses face this reality. When you have insolated and isolated yourself apart from your distinct business operations, you have provided multiple layers of protection in the event of the worst case scenario.
An example of a worst case scenario? This is extreme, however it serves a purpose:
- Joseph is a carpenter, who also has experience in handling HVAC, plumbing and electrical work. Joseph has been contracted by Unit A to install a skylight in the foyer of Unit A’s building.
- Joseph completes the installation of the skylight, to the delight of Unit A.
- Joseph is paid in full for the job.
- One week after the job is complete, a storm in the form of small Klaus Schwabs raining down like frogs and lightning like long and hooked, like a Bloomberg, strikes the skylight, slicing right through it.
- The Schwabs make way into the foyer, flooding the foyer within the timeframe of a cocaine-heartbeat.
- The insurance surveyor comes the next day and deems the cause of the incident as an improper use of glass for the skylight. Furthermore, the insurance adjuster states that the overall installation was under par; was not built to properly repel a Schwab storm.
- The insurance company is now coming after YOU.
- And this is why it is imperative that you have insolated and isolated yourself apart from your business activities: without doing so, you directly can be sued to the extent of the very last of your own personal net assets.
- When a business entity is the business activity, the business entity is sued to the furthest extent of it’s net assets. Unless it is an act of gross misconduct/malicious intent/wilful act of harm – you, the person, and your family, have been spared of legal ramifications as well as your household finances.
- It is imperative to form a business entity to absorb the affects of a worst case scenario.
Steps to Organize:
Step 1 • Choose a Name (for your formal business entity):
For instance, Joseph the carpenter above, may opt for the name “Joseph’s Craftsmanship.”
Step 2 • Choose Entity Type:
I advise strongly to organize an LLC, a single-member LLC, when you formally organize your business operations under the bona fide business entity. The reasons for doing so are quite simply:
- There is much less record keeping in the form of assets, records, books, materials and in-house corporate filings/documentation that is needed.
- In the event that you find a potential business partner, or partners, it is far easier to wind-up (in essence, terminate), your single-member LLC, or to expand it to have multiple “managing members”, to draft and enact an operating agreement, etc.
- When compared with the processes and procedures a corporation, or S-corporation call for, the LLC is clean and involves minimal compliance.
Step 3 • Obtain Taxpayer Identification Number:
You will assume now, the business entity will be called Joseph’s Craftsmanship. The formal name once you put the LLC into effect, will be Joseph’s Craftsmanship, LLC.
You must obtain a federal employer identification number, aka EIN, aka FEIN, aka taxpayer number, for the formal business entity.
Form SS-4 is the official form used to obtain the EIN. Most all acquisitions of EINs are done via the IRS website. This is another thing – when “obtain IRS EIN” is punched into Google, there are a flood of search results which are NOT the official IRS website. These companies purposely lure people in to begin the process to obtain an EIN. And I know for a fact these companies make the process of formally organizing your own single-member LLC seem like learning Chinese, from a Dutch textbook, taught by a Russian speaking instructor. These are the types of poisonous, predatory consulting firms/business advisory firms/law firms even – that should be outlawed. However, these businesses are at the heart of the engine of capitalism. (Let’s not get me started, the point is, avoid these online jackals, no matter what.
This is the official link to Apply for an EIN.
The website, at the time of this blog post, looks like this (I am using Google Chrome Browser, on Android, on a Pixel 4a – this is the mobile view):
Once you have completed the SS-4, you MUST save a pdf copy, print a physical copy to enter into a file of organizing documents – we shall call it your Entity Records for the purpose of this explanatory entry.
Step 4 • Organize:
(which is also called “incorporate,” however, I am sticking with the term organize for people make the obvious association of incorporate with corporation – and we are forming a corporate entity, we are not forming a corporation.)
Organize here means to prepare and file a Certificate of Organization with the Secretary of State within one of the fifty states in the United States. I am located in Massachusetts, where the official filing of an LLC is called a Certificate of Organization.
There is basic, straightforward information that is entered into the Certificate of Organization. The aforementioned predatory consulting firms will make this seem like organ replacement surgery. It is not that complicated when you are completing the filing for your own business operations.
The criteria you will use includes the following:
- The name of the business (matching the name used on Form SS-4, Obtaining the EIN).
- The name (your name) of the single member.
- The address of the business entity.
- The date the business entity
- The general nature of business operations to be stated in the appropriate section. In the case of Joseph Craftsmanship, LLC, it would appear to this effect:
- Joseph Craftsmanship, LLC primary business operations are in carpentry, managing construction projects and assisting it’s clientele with finding the appropriate resources to complete more complex building jobs. The business may also take part in any other lawful business activities in the Commonwealth of Massachusetts.
Step 5: Obtain DBA Certificate, aka “Doing Business As”:
This step is highly recommended to perform. The formal business entity, Joseph Craftsmanship, LLC may wish to advertise using the name “Joseph Craftsmanship” – omitting the LLC in the name. Or, an entirely different trade name may wish to be used in advertising, for instance, “Joe’s Crafty Work” – used in the place of the long form business name.
This is legal to do as long as you procure a “Doing Business As” certificate. In the municipality in which the LLC is located, the official address of the LLC as cited on your Certificate of Organization, visit the town/city hall in that municipality. There, you will apply and obtain the DBA Certificate by bringing your Form SS-4, Certificate of Organization and a means of payment.
It is customary that the cost of the certificate will be between $25 to $150, some municipalities may cost more. However, the validity of the DBA Certificate lasts for between two to four years.
This is a proper step to undertake, for the matter of doing good, prudent business, is the intention of this advise.
Step 6 • Make Customers/Clients Aware of New Taxpayer Identification Number via IRS Form W-9:
Working in the capacity of an independent contractor, it is commonplace that compensation is paid in a pre-tax amount. After the end of the tax calendar year, the client issues you a 1099-MISC which will report the total amount that the client paid you over the tax year. It is important that going forward, the client is acknowledging that your business operations are contained within a newly created taxable entity.
Form W-9, Request for Taxpayer Identification Number and Certification, is the form the client is supposed to issue you when requesting your taxpayer number. Once you have created your new business entity, submit a new Form W-9 to the client. This is an important formality in the spirit of insulating and isolating yourself apart from your business.
Step 7 • Open Commercial Checking Account:
At this point, you now have procured the following:
- Form SS-4: Taxpayer Identification Number
- Certificate of Organization
- DBA Certificate
It is now imperative that as checks, electronic payments and otherwise are made to the order of the LLC directly, or perhaps will be made to the trade name (DBA) you are using, you must open a commercial bank account as this is where payments should be deposited to.
The same applies here if you have a PayPal account. One should be opened to conduct business from.
It is advisable to visit the bank in person. You are the sole member of the LLC, as will be made clear on a completed and filed Form SS-4 as well as contained within the Certificate of Organization. Verifying your identity is required. Your drivers license or government issued identification will be needed to open the account.
Using the commercial bank account:
- Deposits of any physical checks received
- Destination of any electronic payments received
- Utilize to make payments for any and all costs encountered going forward in the ordinary course of doing business.
- In doing so, this will be advantageous when it comes time to performing the accounting for the business.
- It is quite commonplace that those that have organized their business entity forgo performing bookkeeping over the course of the operating cycle (calendar year). However, at the very minimum, the income, expenses, member contributions and distributions are now being facilitated from one source, a source that is under the technical ownership of your business entity.
Step 8 • Obtain a Commercial Business Insurance Policy:
This is imperative. Ordinarily I will advise clients that this should be the first expense incurred by the LLC. The objective of this entire process has been to insulate and isolate oneself apart from their business activities, so that in a worst case scenario, in a court of law, the maximum preemptive safeguards have been carried out which establish the firewall we are aiming for.
Depending upon the nature of your business activities, if you have a vehicle – many factors – this will determine the components of the commerical liability insurance policy.
- Professional liability coverage
- Commercial property coverage
- Employment practices liability coverage
- Commercial crime coverage
- Commercial auto coverage
- Errors and omissions coverage
- Commercial general liability coverage
An experienced insurance agent will be instrumental in obtaining the appropriate policy and coverage.
Remember, this is done for the purposes of insolation and isolation from a worst case scenario.
The most thorough steps to insolate and isolate have been achieved at this point:
- Name of business entity
- Taxpayer identification number
- Certificate of organization for LLC
- “Doing Business As” (D/B/A) certificate
- Commercial checking account
- Insurance policy