By Lonny D. Thomas
On average, I probably talk to at least one business person each week who asks me whether I think it would be appropriate or necessary for him or her to incorporate his/her business. (By incorporating, I mean operate the business as a corporation, limited liability company or other type of recognized business entity, all of these specific issues will be addressed in a separate blog. For purposes of this blog, when i say “incorporate”, I mean operate my business through a separate legally created business entity, regardless of the type of entity selected, rather than through the individual as a sole proprietorship.) Let me start by saying that it is almost never absolutely necessary to incorporate, the question is more whether it would be appropriate or prudent to incorporate.
The primary legal reason for incorporating your business is to protect your personal assets from claims or liabilities that are incurred by your business. The importance of this fundamental concept is not fully appreciated or understood by many business owners.
Incorporating your business essentially creates a different “person” that is responsible for the debts of the business. Subject to certain exceptions, most of which you as the owner of the business entity will control, the corporation is exclusively liable for the debts and obligations of the business operated by the corporation, not you individually as the owner (shareholder) of the corporation. Conversely, the individual owner of an unincorporated business generally will be held individually liable for the debts of the business.
That does not mean that all persons who operate a business should always incorporate. In addition to the initial costs of setting up the corporation, there are other expenses caused by operating as a corporation which could militate against incorporating. For example, a corporation must file its own separate income tax returns and maintain separate financial books and records, all of which cost money.
Although there certainly are businesses for which it probably does not make sense to incorporate, I think it is fair to say that it makes more sense for most businesses to incorporate. There are a few rules of thumb that I use in helping clients decide whether it makes sense to incorporate. Just a few of these are as follows.
Does the business have any employees (other than the owner) for whose actions the owner could be held personally liable? It generally makes no sense for a business owner to expose his/her personal assets to claims asserted against the business owner based only upon claims for the conduct of a third party employee. Creating a protection barrier against such claims against the owner and his/her individual assets is a sound basis for incorporating.
Does the business use vehicles that are operated by either employees or independent contractors in the operation of the business? Your insurance agent will tell you not to worry about this element. But with all due respect to the insurance business, insurance companies are in the business of accepting premium payments from customers and then denying coverage/claims whenever there is a legal basis for doing so. Whether the claim is covered by insurance is not nearly as threatening if the claim is against your corporation rather than against you individually.
What is the nature of the business you are operating and what is the nature of the claims that can be reasonably anticipated to arise from the business? Some businesses, by their very nature, should not be expected to generate claims that cannot be “fixed” by the business, if they arise at all. For example, a painter or sheet rocker (who has no employees) is likely to be able to repair or otherwise “fix” a customer complaint based only upon the quality of his/her work. Simply, repaint the defective workmanship. Conversely, an electrician, whose defective wiring burns down the house, probably has a bigger problem, and is likely not protected by insurance coverage.
There may also be tax reasons to incorporate, but I am not trained in tax matters and do not provide tax advice. I defer to other professionals in connection with the analysis of this issue. But, I know enough to advise that it is worth looking into whether incorporating will provide deductibility for expenses that not otherwise be deductible if the business were not incorporated.
In sum, I think it is fair to say that most businesses, especially as they become more and more successful, are probably better off being incorporated. If you would like to discuss with us whether it is reasonable to incorporate your business contact us at your convenience.