Sole Proprietorship or LCC vs the E&O insurance 10

[HD10]

I am planning to start a part time business in structural design in Northern California. Most probably small work for residential or minor commercial structures. Have about 35 years of experience in commercial, office, school, residential buildings. I have been trying to decide on the company structure, and liability insurance, and would appreciate any tips and help.

The sole proprietorship is the easiest to form. And I can select a name other than my last name for a DBA. Less paperwork starting and during the year, easier tax filing, less expenses etc. But there is this thorny issue of liability. If something were to go wrong, anyone can sue and come after my personal assets.

On the other hand, an LCC would shield from anyone coming after my personal assets (will it?) if I understand correctly. But the startup paperwork, startup fees, yearly paperwork, yearly fees etc are much larger. Taxes might be just a little more complicated than the above option. Plus, I was told that professional license holders can not start an LCC in CA and it has to be a PLCC. Even a PLCC is not allowed for structural engineers in CA. Which leaves only an S corp as the option from perspective of keeping my personal assets separate form the company. Lot more time and fees to set up & operate, more fees and paperwork yearly, double taxation etc.

Are SEs generally operating under sole proprietorship? Do they tackle the issue of lawsuits and someone coming after personal assets by getting an E&O insurance? And does that strategy actually take care of that particular issue and gives you peace of mind?

If yes, how much E&O coverage is enough? 250k? I do not anticipate having billing of more than 15-20k yearly, at leas in the beginning. Which companies are best for premiums and for handling of claims? I hear the names of Hiscox and Travelers.

Sorry for the long narrative. Any tips would be appreciated.

 

[JoelTXCive]

In today's world, when you get sued, the party suing you always tries to 'pierce the corporate veil' and go after personal assets. If it's a small company they will attempt to go after personal assets regardless of the entity structure.

In my opinion, you want to create as many barriers as possible in front of your personal assets and wealth. That means you want to set up an LLC, or a partnership if you have partners.

The business advisors and attorneys I have talked to all seem to stress that you have to set up a separate legal entity and then keep the business assets and personal assets separate. That's your best chance of keeping the personal assets safe.

If you loan money to the company, then you need to have a written loan document. Don't use the company checkbook to buy personal items. Do actual expense reports. etc. etc.

 

[KootK]

I roll the other way. I'm currently an LLC and wish that I were a sole proprietorship. Here's why:

1) I've heard that the layer of liability protection offered by incorporation can be quite ineffective at times.

2) If you get sued as a structural engineer and lose, the most likely reason will be that you did something wrong. It happens. As I understand it, this is the very scenario where your LLC liability protection is the weakest.

3) In many jurisdictions, I've found that sole proprietors have exemptions and relaxations regarding practice permits, COA's, quality control practices etc. Over the years, I've spent a great deal of time, energy, and money on these things that could have been avoided. When it's just you, you really do have to be cognizant of the amount of energy that goes into all of this bullshit administrative stuff that you employer normally take care of.

4) In my opinion, a sole practitioner's best defense IS their insurance policy. This is what lawyers will mostly want to come after because it's represents the best ROI on their invested time. They'll be reluctant to come after your shack in Sacramento and your 1989 Toyota Corolla for fear that a) they might lose and b) the assets will be more of a pain in the ass to deal with than the effort justifies. Yeah, I'm inclined not to leave $400K loitering around in my checking account rather than invested somewhere. But, then, you'd have to be some kind of special moron to do that anyhhow.

5) All of the annoying administrative hassles that you mentioned.

My insurer is AXA XL via a local broker. They're a mega-conglomerate but, at the same time, have been great with regards to service and flexibility on my ridiculously small, international policy. I carry $1M right now and will probably bump up to $2M. When somebody asks for your insurance certificate, even for high end residential, I find that they often want at least $2M. My insurer tells me that, at my ridiculously small scale, I have the cheapest insurance possible even if I did no work at all. And doubling or tripling my coverage basically doubles and triples my premium at my level. There are efficiencies of scale if, indeed, you have scale. KootK gots no scale.

 

[Aesur]

Based on what I recall you are correct that Engineers cannot setup an LLC in California. We are setup as an LLC and file taxes as a pass through S-Corp. It wasn't that difficult to setup, however we aren't in California. We actually try our best not to do work in California because we have heard horror stories of how if you do even one little project in Cali they want to tax you on ALL work you do in ALL states and you have to fight it, so not worth the headache at the moment.

I agree with JoelTXCive - no matter which way you go, you want to setup barriers between personal assets and business assets, this is why most engineering firms actually rent rather than own property as well, no assets means nothing they can "take".

For insurance, there are normally minimums required, most commonly architects/contractors require a 1 million / 2 million policy as a minimum, and it goes up from there based on clients and project sizes. I believe the insurance company also assumes you will do a min of 250k a year as the base for their rate calculations. I suggest looking into this more as it will run you between 5 and 10k a year starting based on their base assumptions. (other carriers may have lower base assumptions)

 

[WARose]

On the other hand, an LCC would shield from anyone coming after my personal assets (will it?)

It beats nothing. The corporate veil is harder to penetrate than people think. The Operating Agreement of your organization should indemnify you for any actions you take as a agent of the LLC. Look for that when the lawyer draws it up.

Nothing will keep some ambulance chaser from trying to go after your personal assets.....but it is tough. To get outside of the corporate veil, it has to be criminal type negligence (not general incompetence). At least that is what most lawyers have told me.

[red]EDIT:[/red] Something else....a lawyer strongly urged me once to never forget to use that COA stamp on drawings.

If yes, how much E&O coverage is enough? 250k?

I'm not sure if 250k is worth getting. If anything happens, they will likely be after more than that. I've talked to some LLC owners who won't get E&O period because they think it just makes them a target. But it is whatever you are comfortable with.

 

[HD10]

JoelTXCive and Aesur, sure it would be good to create more barriers to personal assets. The cons of LLC or S corp are significant too. Maybe those are worth it, in the end. I am curious what most small startup engineers do though. Whether they start as Sole P. and change later when things get going? Or whether most people start out as LLC or Corp?

I also hear that in some cases the lawyers can actually pierce through those corporate barriers too like KootK above seems to be implying. Is there some specific cases where those barriers can be pierced?

Aseur, if the 5-10k premium is based on 250k billing, that wont work for me since I am only anticipating 15-20k billing. Does ASCE provide a better option?

 

[KootK]

I'm going to try to summon member Ron for you. He's exceptional at this kind of stuff.

 

[HD10]

KootK, can you share some observations where the corporate barrier did not help in going against personal assets? I have heard too, but have no observation.
And what is "COA's, quality control practices"?

It does seem logical that the lawyers will go after the insurance, or will go after someone with deep pockets. I wonder if one were to keep most personal assets under spouse name, will those be shielded from liability lawsuits.......

 

[WARose]

can you share some observations where the corporate barrier did not help in going against personal assets?

I talked to a guy who was responsible (his license was revoked as a result) for a collapse where several were injured and one was killed....and they didn't go after his assets.

Now I don't know if that was because they had juicier targets elsewhere (in terms of assets, they did)....or the corporate veil. But he came out ok.

 

[KootK]

A blurb by some lawyers on piercing the corporate veil: Link

 

[HD10]

Sorry for not being knowledgeable. What is COA stamp?

 

[HD10]

From those examples, it seems a sole proprietor setting up a corporate, could get his/her veil breached by the court, if not extremely careful.

 

[Ron]

A good lawyer can pierce any corporate veil if it is truly a veil.

As for corporate entities, almost any of them provide some protection. A sole proprietor should have insurance protection as should the others. Anything other than a sole proprietor makes the other side work harder....and sometimes it's not worth the effort.

More important than any of then entities is how you structure your terms and conditions (as WARose alluded). Secondly, many states either allow or do not allow professionals in a corporate entity to be sued individually. (my state did not allow it for many years, now they do)

Make sure your indemnity clauses are tight. Have your client indemnify you for everything except your own negligence (you can't get out of that). More importantly, be careful in your practice. Remember that everything you produce will be scrutinized by both a lawyer and another engineer who might have a different opinion than yours. Keep that in mind.

I am attaching a booklet I wrote quite some time ago, but remains applicable. Further, if you have a copy of "Principles and Practices of Commercial Construction", 10th edition, read Chapter 1. It contains similar info.

 

[WARose]

Sorry for not being knowledgeable. What is COA stamp?

Certificate Of Authorization. Many states require that for a firm to operate in their state. It's the first thing you should get after starting a LLC.

https://www.harborcompliance.com/information/engineering-firm-license-certificate-of-authorization

From those examples, it seems a sole proprietor setting up a corporate, could get his/her veil breached by the court, if not extremely careful.

Caution is called for. Especially the part about commingling assets. I remember my lawyer specifically warning me about private purchases with the LLC account.

 

[JoelTXCive]

This is a good thread. This is outside of my expertise, but once you do start doing business, then your professional services agreement is also a super important document where you lay the groundwork for defending personal assets.

As Warose mentioned....Having your company indemnify you personally AND having the client indemnify you personally in the professional services agreement is an important thing to do.

I work for a large engineering firm, and I think our agreement says that in the end we are only liable for the fees we charge. So in theory, absent gross negligence, we can just refund our fee. (i have my doubts on that holding up in court, but that's what's in the agreement).

 

[XR250]

For me, it is more about the significant tax benefits of an S-Corp (in the US anyhow). I have no doubt my corporate status would have much effect on things legally.

 

[Ron]

Our terms and conditions require the client to indemnify me and anyone else working under our umbrella. Different states have different laws on indemnification and limitations of liability. We always try to limit our liability to the amount of our fee; however, we have given that up to our insurance limits on some jobs. We carry $1M in professional liability and $1M in Commercial General Liability. For both policies, we pay about $14k per year.

We also don't give up ownership of our documents. Many public projects require that, but we hold fast on that. You don't want your files opened up to just anyone and you don't want your work product re-used without your permission and getting paid for it.

 

[IRstuff]

Malpractice is a personal liability, not corporate, which no company can shield you from. If E&O your insurance is depleted, then your personal assets will be at risk.

https://www.nolo.com/legal-encyclopedia/limited-liability-protection-llcs-a-50-state-guide.html#:~:text=Thus%2C%20forming%20an%20LLC%20will,commit%20related%20to%20your%20business.[/URL]]Personal Liability for Your Own Actions
There is one extremely significant exception to the limited liability provided by LLCs. This exception exists in all states. If you form an LLC, you will remain personally liable for any wrongdoing you commit during the course of your LLC business. For example, LLC owners can be held personally liable if they:

personally and directly injure someone during the course of business due to their negligence
fail to deposit taxes withheld from employees' wages
intentionally do something fraudulent, illegal, or reckless during the course of business that causes harm to the company or to someone else, or
treat the LLC as an extension of their personal affairs, rather than as a separate legal entity.
Thus, forming an LLC will not protect you against personal liability for your own negligence, malpractice, or other personal wrongdoing that you commit related to your business. If both you and your LLC are found liable for an act you commit, then the LLC's assets and your personal assets could be taken by creditors to satisfy the judgment. This is why LLCs and their owners should always have liability insurance.

TTFN (ta ta for now)
I can do absolutely anything. I'm an expert!

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[phamENG]

I started my practice in early 2020 as a side job as well (Virginia, though, not California). I did it as a sole proprietor and got a $1M/$1M E&O Policy. My carrier is the same as KootK's, and I also got my policy from a local broker. I was anticipating annual revenues between 10K and 20K, so I wasn't too worried about the SP structure - most of it was assessments and evaluations with limited liability exposure. Not much design work. Well things took off and I started getting more and more design, so I changed gears. Quit my day job and restructured as a PLLC filing as an S-Corp. I get the protections of a PLLC and the tax benefits of an S-Corp (and some of a Sole Proprietor). I pay myself a salary and have my taxes withheld each month. My profits are then taxed as a pass through income with no payroll taxes. (For those who aren't aware, self employed taxes in the US to cover social security and medicare are 15.3%). So that's 15.3% of my profits that I get to keep. Still have to pay income taxes on it, but 15.3% is a nice chunk of savings. But at the same time, I can take advantage of the self employed health insurance rule (though some accounting and tax form gymnastics) by reimbursing myself each month for my health insurance premium. I have to have income tax withheld from that reimbursement, but at the end of the year I can deduct 100% of my health insurance premiums as an 'above the line' deduction (doesn't count toward my itemization or standard deduction).

One thing to bear in mind on the protections from being sued...in the vast majority of places a Professional Engineer can be sued individually regardless of whether or not the company is sued. It doesn't always happen, and if the 'company' has insurance they'll often take that and settle, but we all carry some level of personal liability for the work we do as professionals. Talk with a lawyer to find out how this typically plays out in your state. A PC/PLLC/PLLP will often provide the added benefit of not being sued when your partner or another professional in your organization does something wrong. So your partner could get sued, and the company could get sued, but they can't sue you personally for the negligence of other professionals. An regular (non-professional) business structure doesn't afford the same protections to professionals. Again, check with a local attorney to make sure your state does things in a similar manner.

 

[kissymoose]

I'm not sure if 250k is worth getting. If anything happens, they will likely be after more than that. I've talked to some LLC owners who won't get E&O period because they think it just makes them a target.

Just listened to a CE presentation from an insurance brokerage where an engineer (true case story) took on a project from an architect, didn't do great and seems like he performed outside his expertise, and the building was damaged resulting in a 1M settlement. Funny thing is, he only carried 250K in insurance and just so happened to only pay 250K in the settlement. The architect's insurance paid the rest. Maybe the architect's insurance was more accessible than the engineer's personal assets, but I'll bet if the engineer carried a 1M policy it wouldn't have paid out only 250K.