Why Incorporate?

A friend of mine, who is a bankruptcy attorney, related a shocking story to me the other day. He represented a couple who had their own business. They went in front of the bankruptcy judge. My friend has done dozens of these cases – many with couples who also have a business. There was never any difficulty. In this case, however, the judge quizzed the couple for ½ an hour about their business dealings before he turned to their personal affairs. The standard time in front of a bankruptcy judge is a maximum 15 minutes.

The difference? The couple chose “sole proprietorship” or a “dba” (doing business as) to form their company. Since their business and personal finances were commingled, the trustee had to figure out what was going on financially. Perhaps he was suspicious that personal expenditures were masquerading as business expenses.

He’s not the only one. The IRS audits 1 in 10 Mom & Pop store tax returns.

Many people tell me they don’t want to incorporate because it’s a hassle, or it’s too complicated, or it’s too expensive. All of these reasons are poor. If you plan to be in business, do it the right way. A limited Liability Company (LLC) or S-Corporation helps you separate your business from your personal finances – which, as you’ve just seen above, is more important than you first might think. The government – all governments, whether local or federal – assume you are playing the game straight if you incorporate (given the number of cheats who are incorporated, this is laughable. But no one ever accused governments of thinking too hard about anything). If you are running this business with your Social Security number as a tax ID, you are leaving yourself open to investigation and interference from the government, as well as liability should someone sue the company (which is you) for whatever there is to sue about.

The two forms of incorporating are

Limited Liability Company. This is what most sole proprietors graduate to. It combines the liability sheltering of incorporation, but allows your revenue and expenses on your 1040. For whatever reason, the IRS bothers people in LLCs less. While liability limits are its name, this set-up does not fully protect you from liability. Courts have struck them aside when pursuing fraud and other civil complaints. See the Wikipedia article here.

S-Corporation. I won’t dally around here: I recommend this corporate form for those who are serious about making their business grow. S-Corp assumes the liability of the business, sheltering the person(s) responsible. Taxes are paid by those who own it on their 1040 – but only a proportional share. You can have up to 100 shareholders or 1 person holding all 100 shares. You’ll also have to file an 1120S tax return for the corporation, with a Schedule K for each shareholder showing their pro-rata share of profits and losses – not nearly as big a deal as its sounds if you get your books set up right at the outset (if you are unsure of how to do that, consult an accountant). Adding the Schedule K info to your personal 1040 is easy. While the S-Corp is supposed to shield you from signing personally, many vendors will insist that you give your person guarantee. Fight back. Insist to sign as an officer of the company. Bring your articles of incorporation and your secretary to dealings with banks, office space landlords and the like. More here on the Wikipedia article.

You can use your favorite attorney or The Company Corporation to set up your corporation.

[Disclaimers: 1. Yes, this is an affiliate link. No, I did not write this as an ad to get more sales through this link. We have used this company for ourselves and our clients and are satisfied customers. 2. Dear FTC: Bite me.]