Legalize It

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Written by: Donna Ann Peck 265 views

I don’t mean marijuana. I’m talking about your business. Most creative professionals like to keep things simple when it comes to legal and tax matters. The simplest way to be in business for yourself these days is as a sole proprietor. It involves little cost and no bureaucratic red tape.

LLC or Inc.?

Jump ahead a year. Your business is making a profit. Should you incorporate or form a limited liability company (LLC)? Both have their legal and tax advantages. The answer depends on the type of business you run and on your financial situation.

Consider your type of business

What are the potential risks and liabilities of your business? You want to shield your personal assets from business debts and claims. “In tough times, all businesses can become laden with debts and bills they can’t pay,” says Anthony Mancuso, an attorney and author for legal publisher Nolo Press. “If you have personal assets you want to protect from being taken to pay your business’s debts, you’ll want to form a corporation or LLC.” business2

If it’s limited liability that you want, an LLC provides the same protection as a corporation, and the simplicity and flexibility of LLCs is a clear advantage over corporations. For that reason, most entrepreneurs starting a small business prefer limited liability companies.

Consider your income-tax situation

Owners of LLCs pay taxes on business profits in the same way as sole proprietors. The profits and losses pass through the business to the owners who report their share of the profits and losses on their personal income tax returns.

Owners pay income taxes on all net profits of the business, regardless of how much they take out of the business. Even profits left in the business checking account to meet upcoming business expenses must be reported as income on their tax returns.

“In contrast,” says Mancuso, “the owners of a corporation pay taxes only on profits they actually receive in the form of salaries, bonuses and dividends. Owners don’t pay personal income taxes on profits they haven’t received. The corporation pays taxes on any profits left in the company from year to year. Corporations are taxed at a lower tax rate than most individuals for the first $50,000 to $75,000 of corporate income.

Consider your investment needs

Unlike other business entities, an incorporated business can sell ownership shares in the company through its stock offerings. This makes it easier to attract investment capital and to hire and retain key employees by issuing employee stock options. “Businesses that don’t need to issue stock options and will never “go public” (most, by far), forming a corporation probably isn’t worth the added expense,” says Mancuso.

The Downside

LLCs and corporations can be costly and difficult to maintain. To form an LLC or corporation, you must file a document with the state and pay between $40 to $800, depending on the state. “In addition, owners of corporations and LLCs elect officers to run the company and record important business decisions,” says Mancuso. Incorporated businesses have the extra complexity of filing and paying taxes.

Also be aware that people are falling for quick LLC marketing schemes. Attorney Felicia Vallera notes “a proliferation of corporation services overselling LLC and S corporations. Most of the people who fall prey to slick marketing end with a cool name and false sense of security,” says Vallera. The San-Francisco-based attorney sets up LLCs and corporations for small-business owners. She cautions people not jump into these entities too quickly. “It’s expensive and time-consuming to do it right. There’s a series of filings and set of criteria to have a validly formed LLC. You can’t buy an LLC off the shelf,” says Vallera. decision-making

People often end up with no protection for their homes. “Quite frequently, businesses sued by a disgruntled employee or an unhappy customer try to get through the corporate veil to the personal assets,” she says, adding that 60 to 70 percent are defectively formed and will not protect people’s assets.

The Upside

A corporation and its owners often have a lower combined tax bill than the owners of an unincorporated business that earns the same amount of profit.

Case Study

I was impressed when my friend Cori Brett, who started a new business as a professional golf writer, set herself up as president of Cori Brett, LLC. “I was in real estate for many years and became aware of the litigious nature of California,” she says. “ I wouldn’t think of owning a business without protecting myself.

She considers LLC a good choice. “I like conducting my business through a professional entity that is separate from my personal affairs,” she says. “It’s like a brand.” For the $500 she paid an attorney, she says she sleeps better at night knowing her assets are protected.

Brett also bought an insurance policy for her home office. The $200 annual premium covers loss of income for 12 months, medical payments to contract workers or volunteers who come to her home office. “It gives me some peace of mind,” she says. “If someone doesn’t pay you, you can enter into negotiations under your company name. She hopes she never has to use it.

The learning curve

My advice is to read Nolo Press’s current offerings on the topic. If you are starting a business (by yourself or with others) and trying to figure out whether an LLC or corporation best meet your needs, read LLC or Corporation. This book also covers S corporations, which have some characteristics of the more well known C corporation (including limited liability) but are taxed like a partnership. Then talk to your friends and business associates. Dennis Whiteman, president of Oklahoma-based FastPipe Media, Inc., says, “I have an S corporation and there’s not a huge difference in terms of taxes,” adding that when he incorporated his media production company in 1995, LLCs didn’t exist.