Structure Your Entity for Tax Relief Deductions and Asset Protection

This is a topic I cover more extensively in my audio program “Incorporating Brilliance – What the Rich do to reduce their taxes, protect themselves and increase their privacy”, but I want to discuss it here also because it so fundamental to your business life. There are five forms or types of business structure: sole proprietorship, general partnership, Corporations – “S” and “C”, Limited Partnerships and Limited Liability Companies (LLC’s). Here are some of the major distinctions between them, especially as they pertain to small businesses.

Sole Proprietorship

A sole proprietorship is the simplest form of a business. It is established simply by making the decision to actually go into business. You don’t need to file any corporate documents (though you may still need a business license) – there are no corporate formalities. Just print up a business card (if you want to) and off you go to start your own company. It’s simple, but fraught with danger and misjudgment. Here’s why. Sole proprietorships provide absolutely no asset protection from within or without. That means that if you are sued because of something business related (product liability, for example) you can lose everything you own. Now, most people realize that as business people, their investment and business assets are at risk. They are willing to accept that risk as part of the risk/reward calculation. What many people don’t realize is that as sole proprietors, their personal assets are also at risk. That means if you are sued as the result of a business problem, not only can you lose your business, but you can lose your personal assets as well. That’s right, your home, your car, your bank accounts, etc. Virtually everything you own. That’s foolish and a risk that is unnecessary to take. And there’s also a great tax reason NOT to have a sole proprietorship. It’s called self-employment tax. I call it the self employment tax penalty. Sole Proprietors are subject to self employment tax of 7% of approximately the first $85,000 in income. That’s about $6,000 per year! The cost of setting up and maintaining a corporation is a fraction of that amount, so it makes no sense to do business this way. So, remember to try not to do business as a sole proprietor!

General Partnership

A general partnership is an association of two or more people with the purpose of making a profit. You do not have to have a written agreement to form one, and, much like a sole proprietorship, no formal filing is required. It is also the most risky form of business there is. That’s because with a general partnership, you are responsible not only for your own mistakes and problems (like a sole proprietorship) you are also responsible for the mistakes and problems of your partner(s). Every time you add a partner, you increase the chance of a problem exponentially. General Partnerships have a concept called joint and several liabilities. This means that any member of the general partnership can be held liable separately or jointly, along with another partner or partner. The bad guys get to choose who they can enforce a judgment against, based on who has the deepest pockets and who has the most valuable assets for them to get their hands on. As a practical matter, you may have done nothing wrong, yet you are dragged into a lawsuit simply because you have more assets for the bad guys to attack. Once again, I suggest you never do business as a general partnership.

Corporations

A corporation is a separate legal entity that is governed by state law. This would be one of the safest entities to structure a business by. It operates through its bylaws as well as through resolutions written and adopted by its shareholders and directors. It must not function as the alter-ego of its stockholders. Corporate formalities must be maintained in order to keep the corporation a separate legal entity. The state of incorporation has its own statutes, rules and regulations from which a corporation operates from. We will examine the difference between “C” corporations and “S” corporations in a later section, as well as ideas about choosing the state of incorporation. Sincerely, Drew Miles, The Tax Saving Attorney