Wednesday, November 25, 2009

Corporations, LLCs, and Sole Proprietorships

Self Employment Blog #3

Corporations, LLCs, and Sole Proprietorships


Incorporating your business requires filing long and formal documents with the Secretary of State and the spending of a lot of money on filing fees, legal fees, accounting fees, insurance, etc. just to set up the corporation. Then you have to pay $4,000 annually in various expenses just to keep the corporation alive.

The major benefit of a corporation is to limit your liability in case something bad happens. All your business assets are on the line if the business is successfully sued, and you could be put out of business. However, the corporate structure should protect your personal assets from being seized in a judgment. I only know of one of my clients who was successfully sued and that was because they neglected to deal with a complaint.

There is a marketing benefit to being incorporated. You appear to be bigger than you are. With today’s technology, you can look like a big company with vast resources, when in fact you are one person sitting in your spare bedroom. Appearance of size matters. Unfortunately, some big companies will not deal with you unless you are incorporated.

Finally, there can be a tax benefit to being incorporated. You need to be earning a significant income to take advantage of these opportunities. My rule of thumb is the benefits start to be available when you are earning over $50,000 per year and you break even when you reach $100,000. If you are losing money, a corporation just costs you more money.

To accomplish this you must observe all the niceties of having a business. You will need a separate business checking account in the business name. You should always use business stationery in the company name and sign as president, not just your name. Everything you do for business should be in the Corporation’s name.

Limited Liability Company (LLC).

Like a corporation, you are required to register your LLC with the Secretary of State and pay a filing fee. The fee varies by state. The registration process is easy and generally just a one page form. Then you have to keep the LLC alive by filing an annual report each year. There is of course another filing fee for the annual report.

There are two benefits to an LLC. First, it limits any liability that arises within the business from affecting your personal assets. For example, you start a business painting houses. The first house you paint catches fire and burns to the ground. An LLC will hopefully protect you from losing your house and other assets.

There is more good news about the LLC. If you are the only member you do not need to file a separate tax return for the LLC. The income and expenses of the business go on Schedule C of your personal 1040 tax return. It is also less expensive to run because you are not paying a tax preparer to prepare an LLC return and your personal return.

An LLC has the same marketing benefits as a Corporation but none of the tax benefits.

Like the corporation, you need to be careful to transact all business in the LLC’s name.

Finally there is the sole proprietorship.

Essentially when you stand in the middle of your living room and declare yourself a business you have become a sole proprietor. The niceties of the LLC or corporation do not have to be observed. You can run the business through your personal checking account. You do not have to register with the Secretary of State. You do your work, collect your invoices (hopefully), pay your bills, and keep the rest of the money. At the end of the year, your business activity is reported on Schedule C of your 1040 Form.

The plus side... It is simple to start and close a sole proprietorship. You end it by standing in the middle of your living room and saying, “I’m out of business!” Your record keeping requirements are much simpler. (Record keeping will be explained later.) The cost to stay in business is much lower than a corporation or LLC.

The downside... If something goes wrong, all your personal assets are on the line. They can take your house and all your assets. A homestead exemption will help protect your home. Under federal law, retirement assets are generally not available to creditors.

More bad news… Many large companies will not deal with you as a sole proprietor.

The next blogs will cover the details of business ownership.

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