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When should I have a separate legal entity for my small business?  

April 20th, 2023 | 2 min. read

By Matt Patrick

I have previously written about the need to have a number of checking accounts, including a payroll checking account, when starting or running a small business. An additional suggestion I would make to owners who have more than one location, or legal entity or operate in multiple states is to set up a separate legal entity just to employ all of your employees. Having a separate legal entity for employees to be employed by, instead of the main operating entity, can provide several benefits to a business. Here are a few reasons why a business might choose to do this: 

Liability Protection for you  

By separating the business's employees into a separate legal entity, the main operating entity can limit its exposure to potential liability. For example, if an employee is injured on the job or engages in misconduct, the liability would generally be limited to the entity that employs the employee. This can help protect the assets of the main operating entity from potential lawsuits and other legal claims. 

Tax Benefits for you and your small business

Separating employees into a separate legal entity can also provide tax benefits. For example, if one of your employees works in multiple locations and is employed by both entities, there is a possibility of overpaying state unemployment tax. This is because unemployment is calculated on the first wages for most states. In Tennessee, this is based is the first $7000 of wages paid, so if you paid them $7000 at one entity and $7000 at another entity, you will have double-paid your state unemployment tax for that employee. 

Simpler to manage, more accurate payroll

There are many challenges when it comes to paying overtime for an employee working in one location 30 hours and another location 20 hours. If not handled properly, you as an employer can easily find yourself in hot water with the Department of Labor. More importantly, paying your employees the compensation they are entitled to is a key part of being a good employer. This is not something that is easily managed when paying the same employee at two different legal entities and is an easy way to inaccurately pay your employee. 

Easier reporting for you and your employees  

Lastly, having one legal entity that you pay employees out of means you only have to file the payroll tax forms for one entity per tax filing due. This means only one Federal form 940 and form 941, as well as one state withholding and unemployment return for each state you’re operating in. Additionally, your employees would only receive 1 W-2 from you. There is already enough paperwork to do, why add more than is necessary? 

It can be complicated to figure out the best way to structure your business, especially if you’ve been doing it one way for a long time. If you are looking for guidance on how to start this transition or have additional questions about anything in this article, book a call with us to start the conversation. As always, we are here to help you get just one step better every day!