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So You Want to Be a Corporation
Now that your appetite has been sufficiently whetted by visions of tax-free sugarplums, letâs get down to basics.
Do You Have What it Takes to Be an Entrepreneur?
Consultant Brian Azar, âThe Sales Doctor,â has worked with several thousand people in the past 10 years. He has created the following quiz to predict entrepreneurial success.
On a scale of 1 (lowest) to 5 (highest):
1. Can you work on your own, independent of others, for long periods of time?
2. Can you sell yourself, your ideas, products, concepts, or services? In other words, can you persuasively and effectively communicate to others and be able to draw them into your point of view or project as collaborators, supporters, or customers?
3. Do you have good people skills, such as bonding and rapport? Coaching and managing skills? Sales skills?
4. Do you have good organizational skills: time management? Communicationsâoral and written?
5. Are you organized, structured, and disciplined?
6. Can you make decisions quickly while maintaining your flexibility?
7. Can you learn from your mistakes?
8. Can you take calculated risks, as opposed to procrastinating?
9. How well do you handle money?
10. Do you know your bank managerâs first name?
11. Do you have persistence, tenacity, staminaâespecially when the going gets tough?
12. Do you have a âmastermindâ? (A mastermind is a group of peopleâmentors, role models, peers, other entrepreneurs, or small business ownersâwho support and may assist your vision and goals in various ways.) Finally, and most important:
13. Do you have an idea, service, or product that you love? That you believe in?
A perfect score is 85; a very good score is 60 or higher. Use this quiz to identify the areas in which you need to improve your entrepreneurial skills.
Donât ignore this self-examination. According to Azar, four out of five small business owners go out of business within five years, and itâs not for financial reasons. The top four reasons are:
1. Lack of organizational skills.
2. Poor attitude.
3. Poor sales and marketing skills.
4. Poor people skills.
Donât be a casualtyâbe a success!
Advantages of Inc.-ing Yourself
Until now, most self-employed people have been operating as sole (or individual) proprietorships, a form of business organization in which the individual provides the capital, starts and runs the business, and keeps all the net profits and is taxed on them. As a sole proprietorship, the individual assumes total liability.
One step up in complexity from the sole proprietorship is the partnership, in which two or more people act as joint proprietors: they provide joint funding, joint management, and joint financial responsibility. Unfortunately, like the sole proprietorship, the partners are personally liable to an unlimited degree for all the other partnersâ errors.
A corporation is the most sophisticatedâand protectiveâform of business organization. It is a âlegal person,â completely separate from the individuals who own and control it. A corporation has the power to do anything any person may do: carry on business, own property, lend and borrow money, or sue and be sued. Most important, it offers its shareholders limited liability: its stockholders can lose no more than their original investment; they are not liable for the debts of the corporation.
In terms of limited exposure to liability alone, it pays to incorporate in order to protect your assets. If you incorporate, no one can attack your house, car, or Ming vases if your business fails or if you lose a lawsuit. Although this point is particularly important in such obvious professions as medicine, dentistry, law, architecture, and the construction industry, limited liability plays an important role in lesser-known areas.
One of my friends incorporated himself to produce illustrated science fiction and childrenâs books. For him, too, the primary benefit of incorporation has been limited liability: âI publish authors whose work some people might find offensive and they might sue me as the publisher. Rather than reject authors whose work I respected, but who might be dangerous, it seemed safer to incorporate. If I were sued, I wouldnât be personally liable.â
Although limited liability may be the most attractive feature of incorporating, there are many others. For many people, there is greater ease in doing business. Some stores favor corporate accounts and offer discountsâeven Tiffanyâs.
Incorporating can make job possibilities more attractive to new or future employees. Thereâs a feeling of working for a profitable enterprise associated with incorporation; you can offer employees greater benefits out of pretax dollars. And, of course, you can always offer them a promotion in title instead of a raise.
Then, too, there are medical, life, and disability insurance benefits. Although the Tax Equity and Fiscal Responsibility Act finally let Keogh plan contributions achieve parity with corporate pension contributions, your benefits will be still greater if you incorporate. Incorporation offers you free life and disability insurance. There is even one kind of insurance you canât get as a self-employed person but can get as the employee of your corporation, even if you are the only employee: workerâs compensation.
Medical benefits alone can make it worth your while to incorporate. If you pay your medical bills as a sole proprietor, the amount you can deduct from taxable income is reduced by 7.5 percent of your adjusted gross income. For most people, these deductions can wipe out more than $5,000 in medical bills every year.
But your corporation can write off all your familyâs medical bills; theyâre considered a business expense.
Is your business so profitable that youâve been investing in stocks? Good. Whereas before, as a sole proprietor, you had to pay income tax on all your dividends, now, if your corporation invests in those stocks, 70 percent of those dividends are completely excluded from income tax, and the remaining 30 percent are taxed at only 15 percent if your corporate net taxable income was $50,000 or less, and at only 25 percent if your corporate net taxable income was between $50,000 and $75,000. The maximum rate is 39 percent on corporate net income between $100,000 and $335,000. Then it drops back to 34 percent on net income between $335,000 and $10 million.
Thatâs the good news. There are a few drawbacks, but theyâre mostly minor ones. There will be more paperwork, and you will have to set yourself a salary and live within it. There will be a greater number of taxes to pay, but your total tax bill will be much lower than it was as a sole proprietorshipâespecially if you live in states or cities that impose taxes on unincorporated businesses.
Itâs pretty clear that the advantages far outweigh the disadvantages, and thatâs why more and more people are following their lawyersâ and accountantsâ advice and incorporating!
The Myth of Double Taxation
A little knowledge is a dangerous thing. Hereâs proof: if you tell friends and colleagues that youâre thinking of incorporating, sooner or later one of them will say to you, âBut you donât want to do thatâyouâll be subject to double taxation.â
This statement is fallacious at best and disingenuous at worst. It confuses two separate issues. You will have to pay two taxesâcorporate and personalâbut you wonât be taxed twice on the same money. Whatâs more important, your total taxes will be lessâoften by 30 to 50 percent, as compared with an individual proprietorship.
Letâs look at some examples. In the first set of ...
