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Want to Start a Business? Better Read This First
You may think you can run a successful business without incorporating. Big mistake. Here's why.
Posted 8/ 23 10 at 10:30 PM | Leadership, Starting a Business, Home-based Business, Taxes & Accounting, Legal Issues, Ask the Expert
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Q: Do I really need to incorporate? All of you experts say I do, but please -- I run a nice little business out of my home in my spare time. I don't make a lot of money and really see no need to spend it incorporating. Where I am I wrong?-- J.A.
A: Let me run a scenario by you:
Let's say that your "nice little business" is a cleaning service. You work for landlords, cleaning up recently vacated apartments, getting them ready for new tenants. One weekend, while working on a bathroom and cleaning up a place, you accidentally leave on a faucet while heading out to lunch. The ensuing water damage is about $2,500.
The problem is, the landlord does not want to file an insurance claim on such a small amount and therefore has decided to come after you for the damages.
If you are not incorporated, the landlord could sue you personally for the money, and you personally would be on the hook. And if you are unable to pay, the landlord could garner your wages, attach your bank account, put a lien on you house, or employ many other methods that would both make you life miserable and damage your personal credit.
By not incorporating, you put all of your personal assets and credit at risk and at the behest of your business. Is that risk really worth it?
On the other hand, if you had decided to form your small business as a corporation, the landlord would have no choice but to go after, or sue, the corporation, and not you. While your business assets and credit would be at risk, of course, your personal assets would be protected. The landlord could not legally go after your personal assets to pay the debt, only business assets.
You are protected.
So that is the primary reason any small business would want to incorporate: A corporation is a separate legal entity, standing apart from you. As such, it shields you from personal liability for business debts and obligations (for the most part).
That is not true when, like too many small-business owners, you form your business as a sole proprietorship or also, as a general partnership. Neither of those entities protect you with the "corporate shield" that a corporation affords you. Both of those put your personal assets at risk.
There are other advantages to incorporating as well:
- There are tax benefits, depending upon the type of corporation you create
- Your business will likely be taken more seriously by others
- Corporations have unlimited life, whereas other business forms do not
- Corporations offer the owner anonymity if so desired
- Ownership is more easily transferred with a corporation
The few downsides include:
- The cost to incorporate -- but even then, using software like the kind found at Nolo.com or LegalZoom.com means you can probably even do it yourself
- Complexity and record keeping
Overall, for most businesses, the benefits usually far outweigh the burdens, and given that, the next logical question would be -- which type of corporation is best? That is a tougher call because each small business is different, and each type of corporation offers different things:
An S Corporation is often the preferred business form for many small businesses. There are some tax benefits and other things to consider.
A C Corporation is often used by businesses that expect to grow large and want to be able to freely transfer and sell lots of shares.
An LLC (Limited Liability Company) is also the choice of many small businesses. It is sort of a hybrid between a sole proprietorship/partnership and a corporation.
Deciding which one is best for you will require further research on your part, but one of them should work. Speak with an attorney and read up on each choice.
The bottom line is that there really are very few small businesses that would not be better of by incorporating.
Steven D. Strauss is one of the nation's leading small-business experts. A USA Today columnist, author and speaker, his latest book is The Small Business Bible. If you would like Steve to speak to your group, or if you would like to sign up for his free newsletter, Small Business Success Secrets! please visit his website at MrAllBiz.com. You can also follow him on Twitter at Twitter.com/SteveStrauss.
Want to be part of this column? Ask Steve a question at AOL@MrAllBiz.com.
Want to be part of this column? Ask Steve a question at AOL@MrAllBiz.com.
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Comments (Page 1 of 1)
Although I agree with most of the article, it is important to distinguish between and LLC, versus Sub S and "C" corporations. An LLC is an entity at the state level which was an outcropping of the liability insurance crisis in the late 1970's. For federal tax purposes the LLC is considered a "Disregarded Entity", if you are an LLC you must elect with the IRS as to how you plan to report as an entity. You must choose between 1120 (s or C) or 1065 Partnership. Further, it is important that the business be operated as a business to avoid piercing the corporate veil. Co-mingling personal funds or using business funds for personal purposes, being under capitalized, are among the key items which can result in piercing the corporate veil and eliminating the limited liability protections.
Although I agree with most of the article, it is important to distinguish between and LLC, versus Sub S and "C" corporations. An LLC is an entity at the state level which was an outcropping of the liability insurance crisis in the late 1970's. For federal tax purposes the LLC is considered a "Disregarded Entity", if you are an LLC you must elect with the IRS as to how you plan to report as an entity. You must choose between 1120 (s or C) or 1065 Partnership. Further, it is important that the business be operated as a business to avoid piercing the corporate veil. Co-mingling personal funds or using business funds for personal purposes, being under capitalized, are among the key items which can result in piercing the corporate veil and eliminating the limited liability protections.
VERY GOOD , BUT YOU DEFINITELY NEED A BUSINESS ATTORNEY TO UNDERSTAND THE REASONING , OPERATION AND HOW TO AVOID MISTAKES THAT WILL COST BIG DOLLARS AFTER CORPORATION IS IN BUSINESS , WITHOUT FORTHOUGHT OF GOOD ATTORNEY WITH EXPERIENCE IN THESE MATTERS.
Article is mostly true. However the scenerio of leaving the water on, The landlord could still sue you as an employee of the corporation and sue the corporation. If you carry a good liability insurance policy, you should be covered no matter how your business is set up, even as a sole proprietorship .
One could easily get insurance to protect against lawsuits. One must also know that a corporation does not insulate you from being personally resposible for things like payroll taxes. I like a sole proprietership because one doesn't have to pay a salary to take money out of the business. You pay taxes on the net income of the business without regard to owners drawing. It's simple - less fees.
Tom, Tom, Tom. You’re a lawyer and should know that in the real world, incorporating does not assure an individual against lawsuits --- especially in very small companies with the entrepreneur being the only employee. Lawyers will always attempt to pierce the corporate veil.
At best, the owner gets sued and spends beaucoups of bucks on legal fees to successfully remove him personally from the suit. But in other cases, the owners is sloppy in keeping records and the plaintiff’s lawyer can show that the owner acts as an individual, not as a corporate officer. In that case, the owner personally is in deep doo-doo.
Okay, so you are from California and it may have stronger individual protections. But the rest of us need to know more about how to protects ourselves from liability in our own states. Accordingly, I agree with commenter Tjb --- load up with personal liability insurance protection and increase your umbrella coverage.
Jerry Chautin
Business columnist
Volunteer SCORE business counselor, Atlanta, Sarasota & Murphy, NC
Former entrepreneur, commercial mortgage banker, business lender
Follow me on www.Twitter.com/JerryChautin
http://tenonline.org/sref/jc1bio.html
The issue of leaving the water on and the $2,500 damages would have easily been solved. Not matter how you decide to form your business you should purchase general liability insureance. This protect your client and your business. Better to have the insureance and repair your clients facility and reating them as a client than to hide behind a corporation without insurance. With insurance you protect your company and should be able to retain the client!
You're a lawyer? You should know that you do not escape liability for you own negligent or intentional acts or ommisions by forming a business entity; you may escape liability for your employee's actions, or the "entity" actions, but not your own. If you negligently cause an auto accident, you will be personally liable regardless of entity or employee status; yes, your employer (entity) may also be liable, but you're on the hook.
I have been in business 16 years as a (Sole Proprietor) and any of the few mishaps like the above stated example were quickly covered under my business insurance - with few questions. Good insurance is a must.
I had a sole propriertorship for almost 20 years. I had no need to incorporate. When I was 60 years old I received notices from the Social Security Administration saying that I was eligible to receive retirement benefits at age 62 even if I were still working. It turned out that just before I turned 62, my clients, also small beusinesses, were having a hard time paying for outside services and were going out of business or cutting down on services and I had almost no income from working, so I applied for the retirement benefit. I was approved, but Soc Sec refuses to pay me. They refuse to send me a notice of denial. When I call they tell me there is a rule, although it's contrary to all the rules published, that because I was self-empoyed and received some income in 2010, for work I did in 2009, I can't retire until I am 66.