On my first day of law school, I saw an incredibly beautiful woman standing in an elevator with 25 guys gawking at her. I introduced myself and asked her out to dinner, oblivious to the snickering guys waiting impatiently for her to put me in my place. Instead, she said yes and we became fast friends for years. I have a great memory after taking this big risk.
I am often asked if new businesses should take on the risks of operating as a sole proprietor or spend the time and money to incorporate (or form an LLC). Here are my thoughts.
If you properly incorporate and operate a business, you are normally personally protected from the claims of creditors. If the business fails, the banks, customers, landlords, employees, etc. typically cannot make a valid claim against you personally (unless you guaranteed the corporate debt). Likewise if the business breaks a contract you are generally protected.
Further if any employee gets hurt or hurts someone else, you generally are protected as well. However this is a more complex area of law, especially with Workmen’s Compensation, general liability insurance policy, etc., but the statement is generally true.
All of these risks increase if you have more than 15 employees due to special state and federal labor laws which can be real tricky.
A tax benefit of incorporating may be lower tax rates. It may be possible to split income between the corporation and yourself. The income is then taxed at the lowest tax rates of each rather than at the highest rates of an individual. This income splitting can be limited in smaller personal service type corporations. There may also be certain fringe benefits that may be more favorable to corporation.
Another tax benefit of incorporating is unpaid payroll tax liabilities. These can be transferred to the responsible party individually, but not all of them. The IRS is certainly a preferred creditor but not an absolute one.
So I favor incorporation. But if you do incorporate it is essential that you do so properly. Lots of people do this on the cheap – using cheap websites or 800 numbers with enrolled agents or an accountant. This is supposed to save them money.
In the long run it doesn’t.
The problem is that transferring a business to a corporation can be a taxable event and create an unanticipated tax problem. Also, the inability of a creditor to pierce the corporate veil and pursue you individually may be lost by failing to use the proper formalities in forming the corporation or in the future operation of the corporation.
So folks, I took a risk that paid off– I looked like a fool but it was worth it. Those of you starting a business are also taking a risk – which can be minimized by careful formation and operation of a corporation with a trusted advisor.
David Leeper is a Board Certified federal tax attorney with 38 years experience . He can be reached at 915-581-8748 or by email at firstname.lastname@example.org