| -"Why should I incorporate? I can just do this business | | | | use of both the C and the S corporation. On the other |
| as a sole proprietor, right?" | | | | hand, because of the nature of corporations, you will |
| -"Isn't it complicated and expensive to form a | | | | never want to use either type of corporation to hold |
| corporation?" | | | | real estate. Instead you will want to use a limited liability |
| -"I run my business with my spouse, and we have a | | | | company or a limited partnership. However, if you are |
| partnership. Why would we need to have a | | | | a real estate investor, there might still be room for an |
| corporation?" | | | | S- or C-Corporation in your overall business structure. |
| These have to be the most frequently asked | | | | For example, a corporation could be used to manage |
| questions that I--and my own financial and legal | | | | your properties held in another entity. |
| advisors--get from our clients. The vast majority of | | | | Or--and this is a strategy that could be used for |
| people who operate small business or home-based | | | | conducting various sorts of business-the corporation |
| business are sole proprietors or mom-and-pop | | | | could be part of another business entity. For example, |
| shop-type partners. Yet, leading authorities on small | | | | if you wish to operate a limited partnership, you will |
| business estimate that at least 90% of all small | | | | need to have a general partner. But the general |
| business and home business entrepreneurs would | | | | partner is responsible for all decisions made and all |
| benefit from incorporating and using a corporation as | | | | liability resulting therefrom--the general partner, in short, |
| an essential component of their overall business | | | | has unlimited liability. Thus, an intelligent option is to use |
| structure. | | | | an S- or C-corporation to be the general partner. This |
| If this is true, why do so many entrepreneurs elect to | | | | way you have a general partner with the limited liability |
| operate as sole proprietors and general partners | | | | associated with the corporation. |
| anyway? And why would you be better off | | | | 3. Know How to Manage Your Corporation Properly |
| incorporating? | | | | to Keep the Corporate Veil Intact |
| The answer to the first question is usually either | | | | Regardless of where you establish your corporation, |
| (1)ignorance of the tremendous risks of operating in this | | | | you will need to make sure that you observe |
| manner or (2) lack of familiarity with corporations and | | | | appropriate formalities--otherwise your corporate veil |
| other legal entities and the ease with which they can | | | | can be pierced very easily, thereby defeating the |
| be established. I should add that if the sole | | | | entire purpose of setting it up. Even if you have an |
| proprietorship is perilous, the partnership is more than | | | | accountant who handles your bookkeeping and tax |
| twice as bad. This is because the partnership is by | | | | returns, it remains your responsibility to assure that you |
| default a general partnership, in which each partner is | | | | are doing this correctly. |
| responsible for all actions of the company, including | | | | This involves holding regular meetings and maintaining |
| decisions made by the other partner in which she did | | | | minutes in your record book, issuing stock certificates, |
| not participate. Now that's frightening! | | | | and other formalities. |
| To answer the second question, we must first | | | | The Personal Service Corporation |
| establish what a corporation is precisely. A corporation | | | | A final issue that may arise, particularly for independent |
| is an artificial legal entity that is separate from its | | | | consultants, translators, and other professionals, |
| owner/shareholders in the eyes of the law. The | | | | concerns the "Personal Service Corporation." There |
| wealthy have learned that there are at least three | | | | are two separate categories of professionals who |
| major advantages that make the corporation | | | | may be affected by this problem: Those, such as |
| anessential component of your business structure. | | | | lawyers, accountants, psychologists, and health care |
| 1. Asset Protection. | | | | professionals, who are required by their state laws to |
| The single most important benefit of the corporation is | | | | incorporate as professional corporations. These |
| protection it affords for your personal assets. | | | | corporations are automatically classified by the IRS as |
| The corporation is created when you file appropriate | | | | personal service corporations. |
| documents--"Articles of Incorporation" in the United | | | | In addition, the IRS has broadened the definition of |
| States--to the appropriate state legal authorities. A | | | | "personal service" to include any work, such as |
| corporation cannot be formed through some private | | | | translation or consulting, that is personally rendered by |
| agreement between the parties who elect to form it. It | | | | the owner/shareholder. This is of particular concern if |
| can only come into being by the state in which it is | | | | you are operating on your own as an individual or as a |
| formed creating it, and it has the rights and obligations | | | | couple. If 95% or more of your earnings come from |
| established by the laws of that state. | | | | work in that personal service activity, the corporation |
| Most important here is the notion of the corporate | | | | becomes qualified as a personal service corporation. |
| veil--this is the shield that separates your business | | | | The reason that this is of concern is that a personal |
| assets and activities from the private person and | | | | service corporation incorporated as a C corporation is |
| assets of the owner/shareholder(s). Because the | | | | subject to a flat 35 percent tax rate and to a lower |
| corporation is a separate legal person, if you are a | | | | ceiling ($150,000) for application of the accumulated |
| consultant or translator, for example--or own a small | | | | earnings tax (normally $250,000). However, this is not |
| store--and someone claims that that they have | | | | an insurmountable obstacle to enjoying the benefits of |
| suffered injury from your business (say, from a poor | | | | incorporating: |
| translation or a slip on your wet floor), and files a | | | | 1. First, the other advantages of incorporating still |
| lawsuit, only the assets of your business are in | | | | render the C corporation preferable to operating using |
| jeopardy. The claimant cannot touch your personal | | | | another structure, such as the sole proprietor. It may |
| residence or your automobile if these are owned by | | | | be especially attractive if otherwise a high earning |
| you and not your corporation. | | | | couple might be subject to a higher tax bracket. |
| There are significant differences among individual | | | | 2. Secondly, it is possible to structure your activities so |
| states and the degree of protection that they afford | | | | that more than 5% of the activity is derived from work |
| to the corporate veil. In California, for instance, there | | | | that falls outside the scope of personal services |
| are a number of occasions--too many for comfort--in | | | | rendered by the owner/shareholder. For example, a |
| which the corporate veil has been pierced, thus | | | | translator or consultant might have a branch of the |
| allowing financial predators to seize the personal | | | | business involved in network marketing--as a medical |
| assets of an entrepreneur. This is almost never | | | | professional might have a health food store or other |
| happened in Nevada, making it the state of choice for | | | | income producing activity--so that the corporation is no |
| entrepreneurs seeking asset protection. | | | | longer qualified as a personal service corporation. |
| We will be devoting a separate article to the Nevada | | | | As you can see, the corporation is an extremely |
| corporation in depth in a future issue of this | | | | valuable tool, one that the wealthy have used |
| eNewsletter. It is important to note for now that an | | | | extremely effectively. If you are operating as an |
| additional advantage of the Nevada corporation for | | | | independent entrepreneur and are not using a |
| many is that Nevada has no state income tax. If you | | | | corporation or the popular alternative of the limited |
| use a Nevada corporation to conduct business in your | | | | liability company, you are most likely handicapping |
| own home state outside Nevada (such as California, | | | | yourself, limiting your profitability and paying excessive |
| our own home state), you may still be subject to state | | | | taxes. With the resources that we have available |
| income tax. Because of the superior asset protection | | | | today, especially over the internet, there is no reason |
| afforded by the Nevada corporation, however, it may | | | | that the average individual cannot easily begin to take |
| still be worth while for you to establish a Nevada | | | | advantage of this valuable tool. We currently have 3 |
| corporation. Large numbers of entrepreneurs from | | | | entities that we formed ourselves and that cost us just |
| other countries as well as other states establish | | | | the cost of the various resources that we purchased |
| Nevada corporations for precisely this reason. | | | | plus the filing fees required by the State of California |
| 2. The S Corporation versus the C Corporation: Know | | | | and postage to get these set up. And we have made |
| Which is Right for You | | | | sure to obtain the proper forms through the sources |
| The issue of the personal service corporation only | | | | we list on our Resources page so that we can |
| comes up with respect to the C corporation. The other | | | | maintain the legality of these entities. |
| type of corporation is an S corporation, which, like the | | | | "Can't I wait and start out as a sole proprietor or |
| limited liability company and the limited partnership is a | | | | partner and incorporate later?" we are often asked. |
| pass-through entity. That is to say that the corporation | | | | Certainly, if you don't mind exposing all your personal |
| is itself not taxed as an entity--instead the net income | | | | assets to risk, paying higher taxes, and finding yourself |
| passes through to the shareholders (such as a | | | | more likely to be subject to an IRS audit. Some people |
| husband and wife), and is taxed on the individual tax | | | | prefer to do things the hard way--but, armed with the |
| returns of the shareholders/owners. | | | | right information and resources, there's no reason why |
| There are situations in which establishing an S | | | | you should have to. |
| corporation would be preferable to using a C | | | | Even if you decide to allow a tax attorney to help you |
| Corporation. If you have significant income from a job, | | | | with the formalities, it is better to do so armed with the |
| for example, and you anticipate significant losses in | | | | knowledge you need to judge whether the |
| early years and you don't anticipate that your business | | | | recommendations she makes are in fact in your best |
| will earn over $150,000, an S corporation will be your | | | | interest. |
| best choice. However, there are limitations on who can | | | | At the very least, you'll know enough to head |
| be members of an S corporation, and there are limits | | | | immediately for the nearest exit if any "expert" you |
| on employee benefits in an S corporation. | | | | consult tells you that you "don't need" to establish a |
| A sophisticated business structure will probably make | | | | legal entity to run your business. |