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.

 

[IRstuff]

I've talked to some LLC owners who won't get E&O period because they think it just makes them a target.

That's crazy talk, I think. We met an ex-ER doctor that got sued for malpractice and lost, and the judgement was way above his insurance level and he lost his house. No insurance will definitely run the risk of losing one's house and savings.

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[WARose]

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.

Malpractice is complicated legally. So is negligence. If someone does due diligence, and makes a honest mistake (maybe a error in judgement) I'm not sure it quite rises to the level of malpractice.

That's crazy talk, I think. We met an ex-ER doctor that got sued for malpractice and lost, and the judgement was way above his insurance level and he lost his house. No insurance will definitely run the risk of losing one's house and savings.

It's up to the individual to weigh the risks. I myself have typically carried 2 million....but 250k? Not sure that is going to mean a whole helluva lot.

 

[Ron]

If someone does due diligence, and makes a honest mistake (maybe a error in judgement) I'm not sure it quite rises to the level of malpractice.

That is exactly why it is important to know your standard of care and practice to it or beyond it. Perfection is not a requirement of a standard of care. Reasoned judgment is required. Mistakes happen. Mistakes don't always equate to negligence. That's why professional liability insurance is often called errors and omissions (E&O) insurance.

 

[TLHS]

This is Canada, but I've been looking into this stuff as well. The Association of Consulting Engineering Companies up here publishes form standard contracts.

The base level limit is $250,000 for a claim. If the engineer holds more insurance, it's clarified that only $250,000 is available to the project unless otherwise specified. They then limit liability to $250,000 (whether covered by insurance or not) plus rework by the engineer. Not repayment of fees, but redoing the work.

The commentary says that limitations that are read as reasonable are generally enforceable. However, the implication in the commentary is that a limitation to something like fees may not seem reasonable depending on the situation, but limiting liability to the insured amount makes it fairly likely that most claims will fall within the coverage available.

Rework instead of having the work done by someone else or returning fees means that you have control over fixing the situation, likely can do it at a lesser cost because you already know the situation, and put yourself in a situation where you can help repair the relationship.

Also, the language they use regarding stuff that may pass this limitation is less terrifying than I understood. They imply that the standard for breaking the limitation may be gross negligence rather than normal negligence.

The standard contract and commentary are available here if anyone wants to look. Once again, this is in a Canadian context. Insurance and Liability stuff is GC 14

https://www.acec.ca/Publications/acec_contracts.html

 

[HD10]

That's interesting. I guess I need to look up some contract language for my startup. I have not ventured in to how will I write a contract. While I may have to talk to a lawyer for drafting one, is there some resource where I can see how to write a contrate? And specially how is the language related to indemnify you...
I am not able to understand why would some client agree to indemnify you for just the fees he/she paid. If the potential loss for example form your errors and omissions was say $500,000, why would they agree to limit their lawsuit just to the fess they paid?

One more thing, I was only looking in to professional liability against the lawsuits. What is the commercial general liability and why is that needed in addition?

 

[phamENG]

E&O covers issues with your design. GL covers day to day stuff. Client comes over to your house to discuss a job and trips on your door sill? GL (your homeowner's may cover it, but if you haven't declared to your homeowner's carrier that you're running a business out of your house they may try to deny a duty to pay the claim). Visit a site and drop a tape or other tool on some poor sap's head from a 4th floor scaffold? GL. Some clients will also require certain car insurance limits, so I have an automotive liability policy tied to my GL as well that covers my business in case I hit somebody going to a job site or meeting.

 

[HD10]

I guess I need to learn the tax things too. I was actually under the impression that an S corp means double taxation. The corp pays the taxes on its profits. When you take those profits out, you pay taxes again as personal income. Is that wrong?
Plus, when you pay yourself a salary, don't the corp have to withhold the payroll taxes already? Or you are talking about the profits over and beyond your salary which may be taken as dividends....?

 

[phamENG]

C corps are double taxed. S corps are pass through, so they don't get taxed at the corporate level. You have to file a separate form (1120?) for the S corp, but no check gets sent with it. The K-1 is produced and sent to the shareholders of the S corp and the profits of the S corp are divided proportionally for tax purposes. If you take more than your portion (you own 40% but got 60% of the profits), the overage is taxed as a capital gain - but that wouldn't apply to you in this case.

By setting up as an S Corp I'm required to pay myself a salary. As just a sole-member LLC, I'd take owner draws periodically. There's a difference. The salary means I'm also an employee, and so the federal and state withholding requirements apply.

Note: I'm not a CPA and don't pretend to be one. Get tax advice from a licensed professional. Same for legal stuff and Insurance stuff. Bar registered attorneys and licensed insurance brokers are the best place fo that. Glad to offer the product of my experience, but take it for what it's worth: a layman's view.

When I'm talking profits, I'm talking profits. My salary is not profits, it's wages. That's what I would be getting paid if I were doing the same thing for somebody else. Profits are my reward for taking a risk and putting my personal capital at stake (either directly through overhead and paying mine and other employee wages in advance of receiving payment from clients, or through liability exposure and the risk of future claims on my or my company's assets).

 

[XR250]

When I'm talking profits, I'm talking profits. My salary is not profits, it's wages. That's what I would be getting paid if I were doing the same thing for somebody else. Profits are my reward for taking a risk and putting my personal capital at stake (either directly through overhead and paying mine and other employee wages in advance of receiving payment from clients, or through liability exposure and the risk of future claims on my or my company's assets).

I kinda just think of it all as how much money I make.
I pay myself 90k - the minimum amount my Acct. recommends without having the IRS get suspicious. The whole "wages versus distributions" thing is just a convenient loophole in the tax code.

 

[WARose]

E&O covers issues with your design. GL covers day to day stuff. Client comes over to your house to discuss a job and trips on your door sill? GL (your homeowner's may cover it, but if you haven't declared to your homeowner's carrier that you're running a business out of your house they may try to deny a duty to pay the claim). Visit a site and drop a tape or other tool on some poor sap's head from a 4th floor scaffold? GL. Some clients will also require certain car insurance limits, so I have an automotive liability policy tied to my GL as well that covers my business in case I hit somebody going to a job site or meeting.

The thing we aren't talking about in this is non-failure issues with design and schedule blow ups. I've seen about 20 times the number of lawsuits associated with missed schedule dates than with any failure. I've never been sure what covers you there (as far as insurance goes).

 

[phamENG]

XR - ultimately that's true, but I find it helpful to differentiate. Because if I'm making a 'normal' salary and then only pulling in 2% profit on my stake...then what's the point? I can make 3% bouncing it around in CDs at credit unions. I might as well be making a 'normal' salary working for somebody else, and let them take all the risk. Or maybe the added flexibility of not having to ask for time off is worth that risk. It's a helpful data point for me when answering the "WTF am I doing" question that comes up every now and then.

WARose - not sure. But I also have a line in my terms and conditions that there are no schedule guarantees.

 

[XR250]

It's a helpful data point for me when answering the "WTF am I doing" question that comes up every now and then.

Makes sense. For me, I could never work for anyone ever again. That question does come up about my chosen career path, however.

 

[HD10]

That's good to know. I didn't realize there are more suits from schedule issues. If it is any help though, when I was talking to the insurance agent re quotes, he did mention the suits related to schedule issues are also covered, same as E&O.

 

[Aesur]

That's interesting. I guess I need to look up some contract language for my startup. I have not ventured in to how will I write a contract. While I may have to talk to a lawyer for drafting one, is there some resource where I can see how to write a contrate? And specially how is the language related to indemnify you...

AIA has some example contracts that may be a good starting point. AIA SampleAdditionally, many insurance providers will provide you with certain language they want in your contracts.

I am not able to understand why would some client agree to indemnify you for just the fees he/she paid. If the potential loss for example form your errors and omissions was say $500,000, why would they agree to limit their lawsuit just to the fess they paid?

I'm sure a good lawyer can tear this apart easily, I believe in many cases it's written in such a way to try to deter lawsuits as it may not be worth the cost of the fight.

 

[Ron]

@phamENG...yes, you are required to show a salary....but that can be $5.00 per year!

 

[phamENG]

Ron...yeah...until the IRS audits you and adjusts the "reasonable salary" number to $90k and you owe back taxes on $85k for every year you've been in business...

Thanks for posting the contract guide...I'll have to read through it when I have time...

 

[TLHS]

Oh I didn't see the question about why a client would limit your liability. It's a question between balancing fees vs liability. You can carry all sorts of insurance if people want to pay for it. If they don't want crazy fees, there has to be some understanding of what the liability you're taking on is. It's not reasonable to take on 500 million dollars in liability just because you were designing a pipe support at a refinery that you're getting paid a thousand bucks for. But there's the chance that the pipe support could fail, start a fire, and burn down the entire place.

Nobody's going to pay the fees necessary to carry the one off liability for something like that.

If you're responsible for a large project, then you'd negotiate a project specific insurance coverage that's reasonable.

 

[azcats]

I don't remember who it was, but one of the older guys in here once admitted he worked his whole career as a sole proprietor w/o insurance.

 

[XR250]

I went for 15 years without it as a Sole Proprietor...

 

[HD10]

How did you protect yourself from potential liability for 15 years? How did you get peace of mind?