A: Assuming the small business is a sole proprietorship, one way to protect your personal assets from business related lawsuits is to incorporate your small business. This limited liability feature of a corporation is one of the most attractive reasons for incorporating your business. Be aware, however, that simply incorporating your small business is not enough to guarantee limited liability. Strict adherence to corporate formalities and proper capitalization of the corporation are necessary.
Q: I am currently partners with two other people in a small printing business and am concerned about my personal liability for the acts of my partners. Is there a way I can limit my liability?
A: You and your partners might want to consider reorganizing your business as a Limited Liability Company (L.C.C.) A limited liability company is a separate legal entity. Similar to corporation, its members are liable for business debts only to the extent of their investment. For tax and accounting purposes, The L.C.C. may be treated like a partnership. This hybrid entity thus offers the best of two worlds - the limited liability of a corporation and the flexibility of a partnership for determining profit and loss shares. The L.C.C. is relatively new in California, but has been used in other states for many years. Your attorney can provide you with full details and help you determine if an L.L.C is right for your business.
Q: I know about the limited liability aspects of the corporate form of business. Are there other advantages to incorporating my small business?
A: A corporation is generally easier to sell and is usually more attractive to buyers than a proprietorship or partnership. This is true because the buyer's personal liability for past operations of the business is limited and the tax issues raised by a sale of stock are relatively simple. The corporate form is also generally more attractive to outside investors because of its limited liability and ease of transfer of an ownership interest. Another significant advantage is that salaries and certain fringe benefits, such as health insurance, term life insurance (up to $50,000) and business travel and meals can be paid to employees of the corporation and are deductible by the corporation as expenses. These amounts paid to employees are not included as income to the employee. There may also be other potential tax savings, depending on the income tax bracket of the owner.
Q: Are there tax advantages to incorporation my sole proprietorship?
A: There is no simple answer to this question. The advantages are related to the relative tax rates paid by the corporation and its owner(s). For example, say Mr. X, a taxpayer in the 31% bracket, owns a corporation that is expected to show a profit of $60,000. Further, let's say that Mr. X wanted to reinvest all of the profits of his corporation in the business. Mr. X would pay around $12,804 in corporate tax on this profit. As a sole proprietor, however, Mr. X might pay as much as $17,861. In this situation, Mr. X benefits from the corporate structure. But, let's say that corporate profits were $200,000, resulting in a corporate tax of $69,607. Mr. X then paid out the remaining $130,393 to himself as a dividend. Mr. X's personal tax would be $45,237 - a total of $114,304 in taxes. In the sole proprietorship form, Mr. X would pay $72,000 in tax - substantially less than the corporate form. Consult with your attorney or tax adviser to analyze your particular situation.