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To Incorporate or Not to Incorporate Part II

Written by: Craig Jennings

Article Overview: The Corporation. Corporations come in three flavors, C Corp, S Corp and LLC. The three have much in common

To Incorporate or Not to Incorporate Part II

The Corporation. Corporations come in three flavors, C Corp, S Corp and LLC. The three have much in common


The major virtue that the Corporation brings to the table is its "persona." Whether it's General Motors Corp. or "You" Corp., it stands as a legal entity or person, protecting its owners and participants from personal exposure to legal liability as a consequence of activities of the Corporation. The U.S. Supreme Court calls it "an artificial being, invisible, intangible and existing only in contemplation of the law."

This is a great vehicle for that Skydiving venture we spoke about before - let's now call it Skydiving Inc. If one of your clients has a dysfunctional parachute and ends up a splotch on the pavement, his grieving relatives will find it difficult to collect from you personally. They can sue Skydiving Inc., and, if successful, take all its assets, but you have interposed this legal entity between them and you. Skydiving is an extreme example - but if someone slips on your stairs or drops your hot coffee in their lap, and you have to answer in court, it's preferable that it's your company's assets, not your own, that are at issue. This protection has been called "the corporate veil" and allows the entrepreneur to compartmentalize his risk. He is not personally liable for debts and obligations of the corporation, beyond the extent of his investment in the corporation. (Oh yes, the IRS and State Tax authorities can come after you for certain unpaid taxes, including payroll. But if the business fails or loses a lawsuit, the general creditors cannot attach your home, your car, or personal property.) My attorney-reader points out that this doesn't make you totally safe in all circumstances. What it does mean is that the path to your assets is much more difficult for a creditor than it would be if you were running a sole proprietorship.


The Corporation has the ability to raise capital by issuing shares of stock, either publicly or privately. Public stock offerings are highly regulated by federal and state governments; but private transfers must simply follow the rules of the stockholder agreement. If someone wants to give you $60,000 for a 30% interest in your company, you will have to issue him enough shares so that he has 30% of the total shares issued. Then you can put the $60,000 in the bank.


Incorporated businesses allow their owners to deduct certain fringe benefits such as pensions, retirement plans and other profit-sharing plans. These deductions can reduce the amount of taxable income that the business declares, and increase the net benefits to the owners


Unlike the sole proprietorship, the corporation's life can exceed yours. This may produce an asset for your heirs which could be lost under the terms of the sole proprietorship.
The C Corp.

The C Corp. provides all the useful features listed above. However, there are also some liabilities:
"Double taxation" is uniquely a liability of a C Corp. Since such a corporation generates its own profit, it is taxed independently of its members. If the C Corp. passes funds on to its owners as a dividend, profit sharing or other distribution, the recipients must pay taxes on the receipts. So the dollar that ends up in your account has gone through two separate tax machines first.


The corporation is a fountainhead of bureaucracy and governmental regulation. Corporate activity is limited and described in law, and the directors must abide by strict regulations. If you overlook the record-keeping regulations or fail to fulfill other requirements such as maintaining separate bank accounts, it's possible for the courts to set aside your corporate status, "piercing the corporate veil." Editorial note: You can get Articles of Incorporation from an attorney, accountant or from internet resources. You'll receive the "Black Beauty" including binder, stock certificates, documentation and corporate seal, and the internet version is usually substantially cheaper. However, the lawyer or accountant should spend some effort on your setup, and provide you with the methodology for maintaining the corporate records successfully. This could turn out to be the far more economical course in the long run, possibly a business lifesaver.


What does the state have to do with it? First of all, the corporation is governed by the laws of the state you're incorporated in. Delaware has been the choice of large corporations for some time. Nevada has become a more interesting choice as the state of incorporation for small businesses recently. For details, your attorney should interpret.


One other "state" issue - corporations have to "qualify to do business" in states where they are not incorporated. How important is this if you have a business in New York and you expect some business from Connecticut or New Jersey? Check with your attorney or accountant.


Finally, closing down a corporate existence, or even changing the structure, can be complicated, and, where lawyers are involved, complicated usually means expensive and time-consuming.


The S Corp. An alternative to the C Corp, the S Corp is frequently preferred by the consultant, sole proprietor, or other small businessperson.



Taxation. Do you recall that in the Sole Proprietorship or partnership, income went straight to your personal tax return? Same for the S Corp, so there's no "double taxation."


The "corporate veil" is maintained.


The structure is far less complex; you simply pay taxes on what you make. Paperwork and bookkeeping requirements are less stringent.


In addition, there's another special benefit - you can "carry forward" losses from prior years to offset current earnings. Since most small business startups are not immediately profitable, it sounds as if this structure was made to order for us.
The LLC or Limited Liability Company. Finally, the LLC or Limited Liability Company may provide you the best of both worlds. While it is not, strictly speaking, a corporation, it provides similar assets, particularly if you're planning an organization with more than one owner.



Taxation. While the LLC is designed to serve multiple owners, it allows the pass-through tax status of the simple partnership - the members pay the taxes, the company does not.


Liability protection. Also, members enjoy limited liability protection - each member's risk is limited to his/her investment in the business. And a barrier akin to the "corporate shield' is in place, so personal assets are protected.


Some disadvantages - with this structure, you must make public notice before you start, by advertising your intention in the news media.


Also, you can't offer stock to employees with an LLC, significant difference from a C Corp or S Corp. Other advantages and liabilities of the LLC are arcane, and best explained by your lawyer.


Cost. Your lawyer will also explain why it may be 3-4 times more expensive to set up an LLC for you than an S Corp or C Corp.
To summarize, we've looked at Sole Proprietorships, Partnerships, the C Corp., the S Corp and the LLC. The first is absolutely the quickest and simplest way to get your venture open for business. The second is designed to give multiple owners an equally fast start. The last three offer some important safeguards, are more time-consuming and expensive in setup and in ongoing maintenance, and should not be chosen without some legal counsel.
(If you missed the prior installments, you can access them on my website, www.craigjennings.com under Newsletter Archives. Look for them.

And, if you'd like a little help now and again to get your small business started, or moving forward more powerfully, I'll talk with you a while (516 944-6454) for free.

That summarizes the available legal structures for our beginning business. Pick one, and let's get on with it. In the next installment, we'll talk about sales, a subset of marketing.

We're tackling sales next for one important reason - without sales, you have no business (or at least, not for very long!)

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Article Tags: c corp, corporations, s corp, three flavors



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