Have you been told that because your business is inside of an S Corporation/C Corporation/LLC, etc. that you are "protected" from a lawsuit? The truth is, while there may be some protection, I'd suggest you are not as protected as you have been led to believe.
There are two types of asset protection as it pertains to corporate structures: One is “Outside-In” and the other is “Inside-Out” protection. Starting with the latter, if something bad happens inside the entity such as one of your employees does something foolish, the corporation and operators of the entity will be sued; this will certainly include the business owner, hence, there is no protection. Think of examples where a large corporation is being sued for some negligence. In virtually all the cases in which I am familiar, the top executives and even the board of directors are included in the lawsuit. Therefore, if you operate the business and are ultimately responsible for the business, there is no real asset protection because you will be sued personally.
The second type of asset protection you should note is “Outside-In”. Currently with three teenage drivers myself, I am well aware that if one of them is in an accident, we could be sued for the assets that we own. Your corporate structure may not protect you in this situation. If an owner of a C Corporation or an S Corporation loses a lawsuit, it is easy to award shares of the corporation to the plaintiff, because again, the “corporate veil” cannot protect you. Regarding this "Outside-In" protection, actually owning an LLC offers slightly more protection since there are no shares to be awarded. In the state of Georgia, all that can be awarded is a charging order which can prove valueless to the victorious plaintiff.
It is important to understand that asset protection is never a matter of doing one or two things and feeling that you've established a bullet proof plan. Rather, the best asset protection is more a matter of the number of barriers that stand between you and your stuff, as well as the difficulty with which it is to break through each barrier.
In addition to an asset protection consideration, there are also tax ramifications depending on which corporate structure you choose. Under an LLC that is taxed as a partnership or as a sole proprietorship, 100% of the income is subject to Social Security taxes (OASDI – Old Age, Survivors, and Disability Income) on both the employer and employee side. This total comes close to a 12% tax up to the social security wage base, which in 2017 is $127,200.* There is also a 2.9% combined Medicare Tax on the employee and employer side for all wages, including those above the Social Security wage base. Within the limits and guidelines of the IRS and after consulting your CPA, if you own an S Corporation or an LLC that has elected to be taxed as a corporation, only your salary and/or bonuses can be subject to Social Security (OASDI) and Medicare tax. Any dividends or distributions paid out as a profit of the business are not subject to either Social Security (OASDI) or Medicare Tax.
In summary, business owners can substantially reduce their tax bill by understanding these rules and seeking guidance from a wise CPA who can advise them on the specifics. Up next, we’ll get into #2 of the 10 Most Common Business Owner Blind Spots series – Liquidation Events and why selling your business may mean a huge paycut. Stay tuned!
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