Ask 100 attorneys whether you should incorporate your new business and my guess is that at least 99 of them will question your sanity if you don't. Attorneys, myself included, have been trained to be "risk adverse", so anything that you can do to protect yourself and your hard-earned assets gets an immediate "YES!!" In fact, there was a time that I could not imagine a situation where you wouldn't incorporate. Keep in mind, when I say "incorporate" I am using the broadest sense of the term which includes not only forming a corporation, but also a limited liability company, or "LLC".
When clients come to me to ask about forming a business entity, my mind immediately races to all the possible scenarios leading my client blindly into potential lawsuits, regardless of how plausible the lawsuit is. One of my "go to" hypotheticals is the delivery boy working for a restaurant taking a deposit to the bank who "t-bones" a school bus full of first graders on there way home from a field trip to the zoo. In my lawyer mind, the moped my errand boy is riding somehow morphs into a tank just before impact, causing such a horrific scene in my head, Stephen King would blush. I would immediately tell my restaurant client she needs to incorporate immediately and keep that errand boy away from small children.
Then, we have "Grandma Emma" who supplements her retirement income by selling her handmade doilies online. She has no employees, works out of her house, and mails all orders directly to the customers. It becomes more difficult for me to imagine a fiery bus crash that ends Emma's business. Thus, the question...When does a business need to incorporate?
First, we should keep in mind the purpose of incorporation, for the most part, is protecting personal (as opposed to business) assets. Therefore, determine whether your business is of a nature that you have exposure to potential liability, and if so, how much exposure. If at 50 years old, you have no debt, your house is paid for, and you decide to retire from a career working for "The Man" to fulfill your dream of becoming a skydiving instructor, I would say your new business venture has some potential exposure. I can see Mr. Skydiver plummeting to earth with his first student strapped to his chest only to crash into a school bus of first graders returning from the field trip to the zoo. (Watch out for the kid on the moped.) On the other hand, Grandma Emma doesn't have too much exposure as she walks to her mailbox to send out the latest order of doilies.
Another factor for any business to consider is cost. Aside from the cost for an attorney to prepare the documents to incorporate, you also get to pay for the privilege of having a business entity. In Tennessee, where I practice, you get to pay the State every year. Tom Carson Jones, CPA, CGMA with Steele, Martin, Jones & Company, PLC, of Jackson, Tennessee explains, "We're in Tennessee, with no regular state income tax. If you go to being an LLC, that's a minimum of $400 in taxes per year (plus an extra tax return for me to file). If we were in a state that has a personal income tax, that same LLC usually costs $10 to $50 per year...but a few states are closer to $200. Point being is that the benefit of being an LLC (or a corporation) really depends on your state's tax structure. Your brother-in-law from that other state really isn't the best source of information."
From the attorney perspective, it's a matter of whether you as a "sole proprietor" have enough potential exposure to justify the $400 expense. If you are straight out of college with no house, a $200 Ford Pinto and a mountain of credit card debt with dreams of owning and operating a mobile car wash, maybe we need to see where you are in a few years before we incorporate. On the other hand, if you are Mr. Skydiver, we need to talk ASAP.
Obviously, these examples are extreme on all fronts. The best practice is to talk to your attorney and CPA to help you determine what is the best approach for you and your business. No shoe fits every foot.
Special thanks to Tom Carson Jones, CPA, CGMA and "The Most Exciting CPA in Town" for his contributions.
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