LEGAL MATTERS: Should You Incorporate Your Small Business?
Wednesday, April 10, 2013
If you own a small business, are self-employed, or if you operate a part-time businesses, you need to consider how to legally organize your business activities to minimize your taxes and to protect yourself from personal liability if things go wrong. To do that, you should know a little about the basic ways of setting up your business.
Sole Proprietorships
Sole Proprietorships are legally owned, controlled and operated by one person. You are supposed to register with your local city or town hall but, other than that, you may not have to file any special paperwork with the state. The biggest disadvantage of being a sole proprietor is you are personally liable if anything goes wrong or if any bill goes unpaid.
A typical sole proprietorship could be Jane Jones, a licensed architect with a full time job, occasionally doing small projects on the side using the name ‘Jane’s Architectural Services.’
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Corporations (Inc.’s) and Limited Liability Companies (LLC’s) are legal entities owned by their shareholders, supervised by a Board of Directors, and run by officers or managers. It sounds complicated but it does not have to be; you could form an Inc., be the only shareholder, be the only director, and be its President, Secretary and Treasurer.
If Jane Jones formed ‘Jane’s Architectural Services, Inc.,’ – even if it was still just her – she would have a legal entity standing between her and personal liability if something goes wrong.
Partnerships
Generally only sophisticated business people, who need certain tax advantages, pay for the legal and financial expertise to operate as partnerships.
Now that you know your options, here are the steps you should follow:
Step 1. Get Accounting Advice
Your first discussion should be with your accountant. He or she will ask you questions about your business and tell you which way of organizing it makes the most sense for tax and accounting purposes.
Small Inc.’s and LLC’s do not have to file complicated tax returns but they do have to pay a minimum state tax, sometimes referred to as a franchise tax, every year. In Rhode Island, it’s $500. In Massachusetts, it’s $456.
Step 2. Get Insurance Quotes
Your next discussion should be with an insurance agent. General business liability insurance is not expensive but if you are a regulated professional (i.e. an engineer, therapist, nurse, etc.), it can get expensive. Although it may be expensive, it is also essential you have it even if you are operating behind the shield of an Inc. or LLC. (Jane Jones the architect, even if she incorporated her business, would be crazy not to have lots of insurance.)
Step 3. See a Lawyer
Once you have tax advice, and an idea how much insurance will cost, go see your lawyer. Your lawyer will probably recommend you form a basic Inc. or LLC. The legal fees for forming a either are generally the same ($400 - $1,200) but the cost of filing the necessary paperwork with the state varies.
Inc.’s and LLC’s have to keep some basic legal records each year and file a simple annual report with the state. If you fail to do either, you will lose all the advantages of being an Inc. or an LLC so pay an attorney to handle it. The legal fee for that annual work is typically a few hundred dollars but the annual fee you have to pay to the state varies.
Legal formalities are the price of doing business the right way. The price of doing business the wrong way is much more.
John Longo is a consumer rights attorney practicing law in Rhode Island and Massachusetts. He represents consumers who have disputes with businesses, employees cheated out of their wages or overtime, car buyers stuck with Lemons, and people in need of bankruptcy protection. He is a member of the National Association of Consumer Advocates, the National Association of Consumer Bankruptcy Attorneys, and the Rhode Island Association for Justice.
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