© 2009. Dan D. Terzian

Taxes aren’t the only reason to incorporate a small business: 
limited liability accounts for 2%.
 

Fact: corporations can reduce your taxes. For me, as a business owner, a corporation was a no-brainer; it made sense on paper, it was easy to form, it was low maintenance; and, it worked as intended. I would do it again in a heartbeat. You can’t ask for a better recommendation than that. I hope I have your attention.

Numerous articles either extoll the benefits or warn of pitfalls in forming a controlled corporation to hold your business interests. Many of these articles are so clinical in presenting the pros and cons of incorporating that the reader loses interest or misses the key issue. The problem is that most of these articles are written by tax advisors and, although they can be quite accurate, they often do not motivate the reader to take immediate action. Many seem overly concerned about possibly misleading the reader or creating a false impression. From my experience business people are, for the most part, busy; and, if not motivated to take immediate action, they don’t do it.

There are no guarantees in business yet most successful business people are happy to work in that environment and are “comfortable” so long as they know the potential risks and rewards. Show me small business owners and I will show you people who have:

•Spent money on promotional gimmicks;
•Hired employees without reference checks;
•Purchased equipment that was never used;
•Signed leases for real property before it was constructed;
•Spent money on one of business’s biggest crapshots–advertising, and,
•Spent money on repairs, maintenance, research, insurance, employee benefits,warranty repairs, customer service or any other routine or non routine expense , because, in the end, it was viewed as a calculated risk, a gamble, or they simply believed it was the right thing to do.

James Morgan, the CEO at Applied Materials Incorporated when I worked there, had the ability to spot talented people. He was known to occasionally hire people, i.e., people that he believed would be valuable additions to the company, even if he didn’t know what job they would have. Sometimes, doing the right thing can look a little strange.

Having a corporation is the right thing to do. Unless your business has a history of losses and you intend to go out of business, a corporation should save you taxes. If your business is profitable and accumulates earnings upon which you are paying taxes, then forget all of the “pros and cons”, forget all of the discussions about “substance”; focus only on this question and just ask yourself: “Why would I not want to save taxes if I have the opportunity to do so?”

A corporation will substantially increase your opportunities to save taxes; that should not come as a major surprise. The surprise is that corporate taxes are computed much the same as that from any other business except for just a handful of key differences: qualified pension and profit sharing retirement plans and employee health and welfare and other employee benefit plans are the most prominent. Surprise, those are the two tax areas that should be foremost in your mind if your business is profitable. In addition, there is the opportunity to (1) choose new, more favorable, accounting methods, (2) control the timing of distributions of profits to the shareholders (3) control the timing and amounts of wages subject to FICA taxes (4) easily arrange your affairs to split income among family members or other controlled entities and (5) easily arrange your affairs to aide in estate planning; all of these are compelling tax reasons to incorporate. And you have your choice as to whether you want to be a C or an S corporation; I know you’ve read enough articles to know the difference between the two.

Now for the doubting Thomas, lets discuss risk: in a nutshell, relatively speaking, there is none. Virtually anything that could have an adverse impact is under your control; you can decide what you do and don’t want to do. Now, in all fairness, there are things that can come up that may have a bearing on what you put into the corporation; and, if you put the wrong things in the corporation, it can cost you money. So here is a Tip: if it going to cost you money to put something into the corporation and you don’t want to spend it, then by all means don’t put it in the corporation. That was easy, wasn’t it? You should put the things into the corporation that need to be there, but that is it.

Some might say that my risk assessment is too cavalier; my response, “Its all a function of your reference point.” Jim DeLong, an attorney I once had the privilege of working with at Applied Materials back in the 1980s, made this observation that I shall never forget:

“If your only tool is a hammer and you only have one nail,
you tend to beat the hell out of that nail.”

Remember that the next time you ask an expert for advice. Every business person I know formed their business without a clue, let alone a guarantee, as to what their first year sales were going to be. How then did they arrive at a sales figure to put into their business plan? They “plugged it”, i.e., they put in a figure that made the business plan look so good that you would be a fool not to buy into it; and then they bought into it with their cold, hard cash and their heart and soul went along as well. The “risks” in forming a corporation are a cakewalk by comparison.

So what does it take to put the corporation together? Obviously, the more complex the business, the more issues will need to be addressed, but its not difficult. There was a little bit of paperwork involved when I formed my corporation in 1997; certain parties, namely the landlord and the bank, had to be notified; other parties were notified out of courtesy and then it was over. Since then there has not been an appreciable difference in running the business from the days prior to incorporation.

Substance? Don’t dwell on it. If you own a business, there are many reasons, just as legitimate as taxes, for forming a corporation. There are those advisors that will caution you that all the reasons of substance must be documented and that corporations are an administrative burden. To that I politely reply, “Not necessarily so.” Many people thought I was crazy to embark on starting my own business when I was 45 years old; some of them were good friends and told me I was crazy. But I did it; I did some things wrong but learned from them. You can develop your own comfort level on dealing with a corporation; its no different than dealing with marketing, advertising, sales, manufacturing, facilities, insurance, personnel, payroll, etc., etc., etc. Many if not most states give you, for free, the forms you need to form a corporation yourself, without a lawyer; its not difficult. In addition, most states allow you to form a “Close Corporation” which is a form of corporation that is somewhat informal. Here is a good article. If you would prefer, there are sources of help available online or go to your own lawyer. It will be worth it no matter how you proceed; I’m “thrifty” and chose to do all of it myself.

In short, approach a corporation as you would any other investment in your business. Evaluate it properly and learn how to use it to your advantage; it will be time and money well spent.