Incorporate a Company

Written by: Andrew Gale - Orange County - Small Business Attorney

In our experience there are three main reasons why you might want to incorporate a business:

1. Perception of Size – Credibility
2. Liability Protection
3. Tax Reasons

Form a Corporation – Perception of Size – Credibility

Some people decide to incorporate a company in order to project the appearance of size.  By this, we mean that by presenting themselves as a corporation they gain perceived credibility with certain clients or suppliers in order to aid in the process of winning business or gaining credit lines.

For example, if I introduce myself as “Andy Gale the Orange County baker”, the person I am talking to is immediately going to make some assumptions with regard to the size and nature of the type of business I represent. Some suppliers may perceive me as too small to deal with, or offer different credit terms because of their perception of the size of my business and my ability to pay on time.

On the other hand, if I introduce myself as “The President of ABC Baking California Corporation” or better yet “I am the Western Sales Manager for the ABC Baking Company Inc. based in Los Angeles CA” the person that I am dealing with may instantly have a very different impression of who I am and the size of my business.

Forming a Corporation for Liability Protection

Let’s explore a simple example.  You have a number of staff working for you.  Let’s say one day you decide you want a Starbucks coffee.  So, you send your assistant “Jill” down to the local Starbucks store in Orange CA.  On her way back, she is holding the coffee but squeezes it too tightly and the coffee pours out all over her lap.  Due to the shock of the hot spilled coffee, she goes straight through an intersection and hits a couple crossing the junction.

When the Los Angeles police interview Jill they are going to ask her where she was going and why.  She is truthfully going to answer “I was getting a cup of coffee for Andy, my boss, during my work hours.”   The injured couple’s personal injury lawyer is going to sue Jill because she ran them over.  Because Jill was acting as your agent that day, they may well decide to sue you too.  If you did not incorporate your business properly and completely, all your personal assets are now at stake.  Your house, your car, your bank accounts, indeed everything could be at risk.

If however, you incorporate your company properly then your secretary would be working for ‘The Corporation’ so the lawyer will sue the corporation for its assets and its insurance policy.  Your personal assets, however, remain protected.

If for instance, you are happily “sewing bears” in your garage in Riverside CA, you might think that there is no risk to you, “Who’s going to sue me for sewing up a bear?”  The bears however have cute little eyes. You may not be aware of it, but there have been a lot of lawsuits about bears that have been made for little kids and the children have a habit of swallowing the bear’s eyes.  The parents then sue because now they have a kid that has severe brain damage.

So with these bears, you may want to consider certain things that you can do to limit the liability in that situation.  It may be how you go about forming a corporation or where you incorporate a business; it may be the kinds of insurance policies that can be put in place that work with your corporation so that if one of these unfortunate events happens you have the best chance of hanging on to all of the assets you have accumulated.

Incorporate a Business for Tax Reasons

Sometimes people are motivated to form a corporation by their accountant who will advise them that they are, ‘getting killed in taxes’.  Or they’ll be told “You make a lot of money, do you understand that you are a high audit profile?”  As a sole proprietor, there’s a certain way that you must prepare your tax return.  You prepare a 1040 form, you then account for all of your business activities on a form called ‘Schedule C’.  That schedule gets attached to the 1040 and it gets shipped off to the Internal Revenue Service.  As that ‘Schedule C’ gets bigger and bigger -numbers in terms of income and in terms of write-offs – the IRS, of course, will put that in a special pile and take a closer look at it.

When you form a corporation, you separate those documents.  The corporation itself prepares its tax return, the corporation itself takes all of those write-offs and the corporation sends off its own tax return to the Internal Revenue Service which is due a month before your personal returns.

When you file your own tax return, it’s a much simpler document.  Income from the business is reflected on a W-2 form that was generated as a result of receiving a payroll check like any other employee from any other company.  The excess cash that was paid out to you as the shareholder of the corporation is accounted for on a form called a K-1. All of the expenses that were previously reflected on the personal tax return are now handled on the corporation’s tax return.  The personal tax return is much cleaner with little or no areas for audit potential.

There are no longer a lot of complicated deductions and expenses, so there’s just a natural statistical tendency to find yourself in a lower audit profile than if you are making the same amount of money as a sole proprietor.  That’s why a lot of accountants like their clients to incorporate. Everyone wants to do what they can to reduce their chance of being on the active radar of the taxing authorities.

By preparing a corporate tax return you are, by analogy, giving your accountant a ten-speed bike to ride up and down hills versus a one-speed bike which is called a sole proprietorship.  There are a lot of ways good accountants will try to duplicate in a sole proprietorship what can be done in a corporation but they are simply not the same.  Business incorporation gives an accountant much more flexibility when accounting for your business money so that it’s done in the most tax efficient way possible.  This is all perfectly legal and it allows the accountant to use a lot more of the tax code to the advantage of the taxpayer.

The tax code is an incredibly complicated document and it changes frequently.  Accountants are required to do hours and hours and hours of education every year to keep up with the changes.  Some accountants specialize in just doing personal tax returns.  There are other accountants that specialize in doing business tax returns for small business corporations and small business owners.  Once the small business owner has formed their corporations, they find those kinds of accountants and basically say “I decided to implement business incorporation in order to give you as a better tool and I need you to help me work my way through paying taxes, but do it in the most efficient way possible.”

Here’s what never happens, the IRS sending you a letter that says “by the way, we’ve taken a second look at your tax return and we notice that you didn’t take advantage of several of the deductions that you can make, so here’s a refund check!” They don’t work like that.

It’s up to you to figure out what all those legal and legitimate deductions are.  By forming a corporation, you are giving your accountant a tool to maximize your deductions.

Based in Orange County California, Incorporation Attorneys’ are specialists in small business incorporation, corporate records, and corporate dissolution.  To take advantage of our ‘try for free’ services simply call +1 (714) 634-4838 or complete a simple incorporation services contact request form and we will contact you.

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