Choosing your business structure
shouldn't be an afterthought
By Jeff Ostrowski • Bankrate.com

Feb. 1, 1999 -- There are a few tasks every entrepreneur tackles when launching a small business: hatch a winning idea, put together a thoughtful business plan, find money.

Somehow, though, the structure of the business is usually an afterthought. Ken Yancey, executive director of the national Service Corps of Retired Executives in Washington, D.C., says startups often overlook the details of incorporation.

"There are tax issues and liability issues," Yancey said. "You don't want to make a mistake that early, especially when there are sources of help out there."

Defining the threshold
Who should incorporate? For the owner of a small, part-time business, incorporation is probably more trouble than it's worth. But if the business has any employees and the company makes more than $8,000 a year, forming a corporation would provide a benefit.

Liability protection and tax advantages are the two main reasons to incorporate.

Unincorporated businesses, known as sole proprietorships and general partnerships, leave owners wide open for financial disaster, experts say. Creditors can go after an entrepreneur's home, car and other personal property to satisfy debts. Having even a single employee can increase liability to the point where protection is desirable, says Frank Rodriguez, head of Corporate Creations, a Palm Beach Gardens, Fla., firm that helps companies incorporate.

Incorporation limits the company's liability to the assets of the corporation. Once those assets are exhausted, so are a creditor's hopes for reimbursement.

Recovering the expense
Tax considerations also are key, Rodriguez said, and $8,000 in company income is the typical threshold where incorporation makes sense.

That's because sole proprietors pay a 15.3 percent self-employment tax on income. An S corporation -- a common type of corporate entity for small businesses -- doles out money in two forms: wages and profit distributions. Profit distributions are exempt from the 15.3 percent self-employment tax. So, Rodriguez said, an S corporation saves $1,530 for every $10,000 profit distribution.

In the case of Rodriguez's $8,000 rule, the entrepreneur likely would pay himself $6,000 in wages and call the other $2,000 a profit distribution. Therefore, the entrepreneur wouldn't owe the Internal Revenue Service 15.3 percent of $2,000, or $306. That's about equal to the cost of incorporating.

The choices
The IRS gives entrepreneurs the choice of five types of business entities:

• Sole proprietorship: This low-maintenance business structure puts up few legal hurdles and costs nothing to establish. More than three-quarters of all businesses are sole proprietorships. The form offers no protection from liability and the structure makes it difficult to raise capital.
• General partnership: A business enterprise owned by two or more persons who share both the income and liability of the business. Doctors and lawyers often use this form. Partnerships offer no liability protection, with every partner liable for the negligence of every partner.
• S corporation: This structure is a favorite of startup firms. It limits liability while sheltering some of the self-employment taxes paid by sole proprietors. The S corporation limits the number of shareholders in the company to 75, and allows for only one class of stock.
• C corporation: So known because it's taxed under regular corporate income tax rules. It also offers liability protection. Unlike other types of business structures, the C corporation's income is taxed twice. The corporate income is taxed, and the dividends paid to stockholders are subject to personal income tax.
• Limited liability company (LLC): This structure is a hybrid of the partnership and corporate forms. It allows the liability protection of a corporation and the tax advantages of a partnership. It lets the company issue both voting and nonvoting stock.

The costs of incorporation
Neither the U.S. Small Business Administration nor SCORE track the state-by-state costs of incorporation. Corporate Creations' basic fee includes the state filing fee and the company's own service fee.

Corporate Creations' costs range from a low of $124 in Delaware to a high of $534 in California, including $199 in Florida, $225 in Illinois, $269 in New York and $416 in Texas.

If an entrepreneur uses an attorney to incorporate, the process could cost as much as $700, said Corporate Creations' Rodriguez.

SCORE's Yancey said entrepreneurs shouldn't try to cut costs by negotiating the incorporation process themselves. Because of the move's legal and tax ramifications, business people should consult with their attorneys and accountants. "I recommend strongly that you engage a professional."

Jeff Ostrowski is a freelance writer based in Florida
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-- Posted: Feb. 1, 1999