We often hear that business owners have a variety of reasons for believing their business does not need to operate as a valid business entity. Unfortunately, these reasons typically turn out to be misconceptions.
When incorporation is done properly and thoroughly, it provides the governing documents that the corporation will use to conduct its business. There are several advantages to incorporating a business, including protection from personal liability and favorable tax treatment. If an individual is conducting business as a sole proprietor or if multiple business owners are acting as a partnership, Michigan law does not provide the business owners protection from legal liability.
It is important to understand that if a business entity is not established properly, legally, or formally in Michigan, the business owner or owners are automatically assumed to be acting as a sole proprietor or a partnership. This article discusses three misconceptions that we frequently hear about incorporation and will explain the risks involved with acting as a sole proprietor or partnership.
Misconception 1 – The business does not make enough money to incorporate.
We often hear from budding entrepreneurs that they do not want to invest the time and effort into incorporating because they do not know if their business will be successful and they do not yet have a high level of profit. This is one of the most dangerous misconceptions for business owners because the level of risk associated with conducting business is in no way related to the amount of money a business makes. If a business owner conducts business without a proper entity and a judgment is obtained against the business for an accident or other matter, the business owner’s personal assets will be used to satisfy the judgment.
Establishing a valid corporation and maintaining the entity protects business owners from personal liability for the actions and occurrences in the business. Creating a separate business identity through incorporation is one of the key factors a judge will use to determine if the business owner will be personally liable for the actions of the business. In addition, obtaining S Corporation status has favorable tax implications for the business owner. It is untrue that maintaining the corporation is difficult or expensive. The yearly requirements to maintain the C corporation are minimal and we educate business owners on the steps necessary to maintain their business entity from year to year.
Misconception 2 – The business does not need to be incorporated because I have insurance.
Insurance policies help protect businesses and business owners by providing coverage for the risks of conducting business. Insurance coverage’s, however, almost always come with coverage limits. If the amount of a judgment exceeds the amount of insurance coverage, the business owner will be liable for the deficiency. Additionally, depending on the type of insurance coverage, some types of claims may not be covered at all by the business owner’s policy. In this case, the business and the business owner would be liable for 100% of a potential judgment.
Misconception 3 – I am protected because I filed a DBA with the county.
Filing your business name as a DBA or “Doing Business As” with the county where your business is located does nothing to protect the business or you from liability. The only thing a DBA protects is the business name in that county. A DBA is not a legal entity and only provides that another business will not be able to conduct business under that business name in the county. If a business operating as a DBA is sued and a judgment is obtained, the business owner will most likely be held personally liable for the amount of the judgment. This means that the person or entity that obtained the judgment can take personal assets and income, such as the business owner’s home and financial accounts, to satisfy the amount of the judgment.
Business owners should have their business entity reviewed to determine if it is the most effective way to do business, and they are legally protected