To Incorporate or Not to Incorporate...That is the Question.

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.

SMALL BUSINESS HEALTH CHECK-UP

Every business, regardless of size, occasionally needs a check-up.  The best practice is to annually review your procedures, agreements and business practices to see what works and what needs changing.  Here is a small business health check to help you get started.

SMALL BUSINESS HEALTH CHECK-UP

I. General Information:
A. Name
B. Address
C. Business entity, if any
D. Number of members/shareholders/partners
E. Are the partners related by blood or marriage?

II. Protection Against Liability
A. Are you utilizing a limited liability entity such as an LLC or S-corporation to protect your personal assets?
B. Is the limited liability entity you are using right for your business?
C. Are you holding annual meetings as required by your Bylaws or Operating Agreement and maintaining minutes of those meetings?
D. Are you using separate checking accounts for your business and personal expenses?
E. Are your directors, officers or members protected from liability and indemnified?

III. Employee Relations
A. Have you collected the appropriate information from your employees to ensure their legal status?
B. Do you have an employment handbook with policies to protect and guide you and your employees?
C. Have you filed the required forms for unemployment and payroll withholding?
D. Do you have policies in place to avoid discriminatory employment practices in hiring, firing and employing people?
E. Are you properly classifying people as employees or independent contractors?
F. Do you have well drafted non-compete and non-disclosure agreements?

IV. Lease Agreements
A. Are your office or equipment leases flexible?
B. Do you clearly understand your lease costs?
C. Are the leases automatically renewable?
D. Do you have a deadline to provide notice to avoid an automatic renewal provision, and do you have a system in place to remind you of the deadline?
E. Have you provided ways to void long-term agreements if there is a change in circumstances?

V. Clear Contracts
A. Are your company’s important agreements set forth in carefully drafted written contracts?
B. Do you have a system for keeping track of important obligations and notice requirements under your contracts and agreements?
C. Have you structured your contracts to minimize personal and business exposure to liability when possible?
D. Can the average person understand your contract?
E. Does your company’s agreements contain protection from liability for defective products and services?
F. Do you have protection in your default clauses so you can recover interest, attorney fees and other expenses if you have to make efforts to collect from a customer?

VI. Litigation Prevention
A. Do your contracts require parties to resolve disputes with cost-effective arbitration or mediation provisions?
B. Do your agreements limit the other party’s right to sue you?

VII. Compliance with Laws and Regulations
A. Does your company undergo periodic legal checkups to ensure compliance with the latest laws and regulations?
B. Do you have current permits for all your business operations?
C. Do you know what your company’s environmental obligations are?
D. Is your advertising truthful and not deceptive?
E. As you expand into new states, are you properly registering your business?
F. As you work in other states, are you paying taxes to the proper local, state and federal agencies?

VIII. Internet Business
A. Is your website content protected?
B. Is your use of third party content allowed?
C. Is your domain name protected?
D. Is customers’ information, such as credit card information, secure?

End of the Year Checklist for Small Business Owners

Nellie Akalp of CorpNet, offers this End of the Year Checklist for small business owners.

The final homestretch is a busy time of the year for the small business owner, with your time pulled between trying to meet end of year sales goals and closing out Q4 projects to holiday planning and parties. However, it’s also a critical time of year for wrapping up any legal loose ends associated with your business.

There are a couple of steps to take to make sure your business is legally fit for 2014. By doing so, you’ll be making sure your business gets the right start in the New Year, and you won’t end up paying extra in administrative fees and fines. Here’s what you need to consider before the calendar hits 2014:

1. Incorporate or change your business structure

If you’re like many small businesses you may have started as a sole proprietorship or partnership. But many businesses eventually outgrow these business structures. If your business is not incorporated, you may want to incorporate (either by forming an S Corp or LLC) to shelter your personal assets and perhaps give you more flexibility and cost savings when it comes to your taxes.

2. Close any inactive businesses

If you’ve ever registered a business with the state and are no longer operating it, you need to file a formal termination with the state as soon as possible. Why? Until that paperwork is in, you’re still going to be charged for any fees associated with the business, you’ll need to file an annual report, as well as submit any tax returns.

To close a business, you need to file an “Articles of Dissolution” or “Certificate of Termination” document with the Secretary of State where your Inc. or LLC was formed. Keep in mind that you will need to settle any owed taxes before you can do this (but again, the sooner you take care of this, the better…when it comes to taxes, ignoring the problem won’t make it go away).

Make sure to take care of these matters while it’s still 2013. There’s no reason to keep paying for a business that’s basically been retired.

3. Hold an annual meeting for your Corporation or LLC

If you’ve gone through the work to incorporate your business, make sure you keep it in good standing. If you haven’t held an annual meeting for your Corp or LLC this year, be sure to get one in before the end of the year. Along with the meeting, you’ll need to generate written minutes/resolutions to be signed by the shareholders (Corporation) or members (LLC). If this will be your first meeting, you can find free meeting minutes online to use as a starting point.

4. Make sure you file an annual report for your corporation/LLC

Most states require some form of an annual report filing (some every year; some every two years). If your state requires you to file this report, there is a specific due date for filing each year. In some cases, it’s on the anniversary of your business’ incorporation date; in other cases, it’s when your annual tax statements are due; and in some cases, it’s at the end of the calendar year. Missing this deadline can result in penalties and late fees, and depleted state budgets mean that we’re seeing several of these late fees grow.

5. File an “Articles of Amendment” to record any company changes

If you made any changes to your business (for example, if you changed your business address, dropped the .com from your official company name, authorized more shares, or a board member left), you’ll need to file an official notification with your state.

This may seem like a pretty trivial thing, but it’s actually essential to keeping your LLC/Corporation in good standing. For example, if your business happens to be sued and your paperwork isn’t up to date, it’s possible that the plaintiff will try to come after you personally.

6. Review your estimated tax payments for 2013

Now that we’re nearing the end point of the year, review what your business has made year to date and assess your estimated tax payments to avoid underpayments or overpayments. You’ll want to adjust your final 2013 payment (which is due Jan 15, 2014) as needed.

The next few months will be busy, but set aside some time to address these legal obligations. It will help you save money in fees and penalties moving forward. And what better gift could you give your business than a fresh start for the New Year?