So you are thinking of going out on your own and starting a new business. Due to tax and liability considerations, you should determine the structure of your new company as early in the process as possible. Will it be a sole proprietorship or some form of corporation?
There are, of course, consequences to this decision. So I teamed up with Robert Long of Coral Springs, Florida to provide you with more specific direction. Robert is a CPA in his own practice (Robert E. Long M.A., C.P.A., P.A.) and has been serving small businesses for decades. As the internet and email has made our world more virtual, he is now serving small business owners in many states across the nation. So here are his thoughts on the subject.
Most business owners cite two main reasons for incorporating:
- To protect personal assets from the risks of the business, and
- To save on taxes.
Both of these are legitimate and achievable goals. However, there are limitations to the benefits most business owners realize in these areas. The extent of tax savings for instance will depend on a number of factors, including how the entrepreneur operates the corporation as well as the choice of corporate form. Sometimes business owners discover too late that they made the wrong decision after all. So, do yourself a favor and gather as much information as possible before making a decision.
By reviewing some general issues before incorporating, a new business owner will make a more informed decision about the process. As always, it is best to see your tax advisor or tax attorney for more details regarding your business in particular.
It is also important to remember that a corporation is a separate entity subject to its own legal and tax rules. Even tax filing dates differ from corporations compared to those for individuals.
As a separate legal entity, a corporation is legally responsible for its own taxes, debts, losses, and other liabilities. If the corporation can’t pay, its shareholders stand to lose their investments in the business, but their personal liability is limited. Thus, to some degree the owner of the corporation is protecting personal assets through the corporate organization. Usually, the shareholder’s liability is limited to the amount her or she has invested in the company. The shareholder is generally protected from the IRS placing a levy on personal assets.
However, there are situations in which a business owner can be held personally liable for money owned by his or her corporation. The most common of these are when the business owner/shareholder has financial control over the corporation. In these cases they can be held personally liable if payroll taxes withheld from employees’ wages are not turned over to the Treasury Department. And the corporation won’t shield an owner from personal liability for professional malpractice or negligent acts while engaged in corporate business. Also, many small business banks and other creditor’s frequently require an owner to personally guarantee the corporation’s debts until the corporate business has established itself with a credit rating.
At this time creditors feel they can rely on an established business to carry its own debt. So you can see that the concept of the “corporate veil” which, in theory, protects personal assets from claims against the corporation, may in some cases be pierced. In some cases, the courts have allowed the IRS and other creditors to pierce the corporate veil and seize shareholder’s personal assets to satisfy a corporation’s obligations. With careful consideration of the legal requirements for running a corporation, this can be avoided. By strictly avoiding comingling of corporate and personal monies, as well as other dominating activities by a shareholder, the corporation should not be considered the shareholder’s alter ego.
Another advantage of incorporating is the continuance of the business beyond the life of the shareholder. Unlike a sole proprietorship, a corporation has an unlimited life span; the corporation will continue to exist even if the shareholders die or leave the business, or if the ownership changes.
The tax treatment of corporate profits and losses depends on a number of factors, including the type of corporation you choose.
In an S corporation (so named for the specific code section in tax law-not because it’s name is “Small Corporation”), the corporation itself will not pay tax. Instead, corporate income and losses will pass through to the shareholders and they will report them on their personal tax returns.
In a C corporation, the corporation pays taxes on its income and you pay tax again when that income is distributed to you as a dividend. This “double taxation” is often cited as a downside of the C corporation.
Other issues to incorporating are the costs involved which could range as high as one thousand dollars in legal and filing fees. There may also be state fees required with the initial setup. Then there is the selection as to whether the company would benefit from being an LLC, an S Corp or a C Corp and the consultations or research involved in those informed selections. You must also budget for the additional cost to have the corporate tax return completed each year. And at some point in the not too distant future the officer will have to be placed on a salary which means quarterly and annual payroll taxes will be required to be filed with various state and federal government agencies. These various fees represent a stumbling block to many startup companies once they are viewed from an initial financial standpoint. However, the long term benefits to a successful and properly structured company to its initial shareholders outweigh initial costs involved.
Of course, the company may initially be started as a sole proprietor and as it grows incorporation may become a “natural” step to take in the future. Unfortunately with this scenario, initial expenses and lack of capitalizing various assets may be lost due to improper accounting. The owners usually are not aware of the benefits lost which may not be retrieved after a period of time has past. The benefits of incorporating a business which has been properly planned for and structured with a long term profitable goal make the personal liability issues as well as tax ramifications and various other benefits the major reasons to move forward with a corporation for a successful business.
This article is a very brief overview and a more detailed look should benefit anyone seriously thinking of starting a new business. As always, it is best to see your tax advisor or tax attorney for more details regarding your business in particular.
Hopefully, this article will give you food for thought. If you would like to contact Robert Long, you can do so by calling him at 954-603-0480 or emailing him at rlong33424@aol.com.
NOTE: If you are starting a new business you may also enjoy the articles, Is Now a Good Time to Start a New Business? and Is a Written Business Plan Really Necessary?
If you are incorporating to protect your personal assets (as most owners do), make sure you read Incorporation: Beware of Mismanagement.
If you would like to contact me, you can do so by emailing me at mike.clough@bestbizpractices.org or visiting my LinkedIn page.
Posted by: Mike Clough
