Chapter 20: Should You Incorporate?

Alice E. Fugate, Fugate Publications

In this chapter, we'll consider the pros and cons of incorporation for self-employed technical communicators. We'll take a look at the types of corporations you'd be most likely to benefit from and the process you would go through if you decide to take the plunge. Since incorporation is more than just a one-time decision, we'll also look at its ongoing responsibilities.

First, let's ask the logical question:

Just What Is a Corporation, Anyway?

A corporation is a legal entity, created under state law, that is authorized to carry on an enterprise. This entity is distinct from its owners. In effect, a corporation is an artificial person brought into existence by an act of the state in which you incorporate.

More terminology: The owners of a corporation are called shareholders or stockholders (a share of stock is a unit of interest in the corporation). The shareholders elect a board of directors, which is responsible for managing the corporation, and the board appoints corporate officers who oversee day-to-day operations. In many small corporations, however, the business owner is also a director and corporate officer.

A key feature of a corporation is limited liability: shareholders' liability is limited to the extent of their investment in the corporation. Generally, this means that if your corporation goes bust, all you would lose are the assets held by the corporation. Personal assets such as your house, car, and personal bank account would be protected. (Ambrose Bierce had a point, as you can see).

Notice we said "generally." If you guarantee a loan with personal assets, or manage your corporation irresponsibly, you could conceivably forfeit those assets. More on this later.

While we usually think of corporations as huge enterprises, in fact they can be any size. If you're a one-person shop, you could incorporate without hiring any employees or partners.

Take a look at Table 20.1, which compares key features of the three major categories of business ownership: sole proprietorships, general partnerships, and corporations.

Table 20.1   Sole Proprietorships, General Partnerships, and Corporations: What's the Difference?

* Note: If you plan to give your business a name other than your own, you should register the business name as a so-called "fictitious" or "assumed name." This has nothing to do with incorporation. For more information, contact your state's secretary of state.

Do You Really Need to Incorporate?

Good question. Before making this decision, take a hard look at your status quo and your business goals.

"The key to succeeding in business is developing a good business plan," says Jeff Dee, assistant director of the Small Business Development Center at St. Louis University. If you don't already have a written plan, sit down and create one. Specify what you want your business to do, who your customers are, and how you will conduct the business. The discipline of doing this will help you determine priorities and focus on achieving your major goals.

You may have a great idea for a business, but do you also have the energy and resources to carry it through? If you work full-time, will you continue at your current job until your business gets going? While this can be a good way to test the waters, make sure job and family responsibilities will leave you enough time to do the venture justice.

Will you finance the business from your own funds, or will you need to borrow money? Incorporation may make you appear more like a "real business" when you approach a bank for that loan.

Many people incorporate because they want to limit their liability. So next, consider the nature of your business and the degree of legal risk it involves. Can you think of any ways in which your product or service could injure someone, or cause a client to lose money? If you create a tangible product, you may well need protection against liability. If you deal in intangibles, this question may be harder to answer.

Talk to customers and competitors. How many independent contractors in your field are incorporated? Do clients prefer to deal with them?

Assess potential risk by asking insurance agents whether they insure many business owners in your field. What types and amounts of coverage do they recommend? Rather than incorporating, some business owners handle liability concerns by purchasing errors and omissions (E&O, or professional liability) insurance. E&O insurance offers some protection against the financial consequences of rendering professional services, but premiums tend to be high. Some technical communicators buy it, although it's more common in professions such as accounting, architecture, and real estate sales. (For more on insurance, see Chapter 15).

Another point to consider: Will you work alone, or with other people? If you plan to hire employees or take on a partner, it's smart to incorporate. You could be held liable for mistakes made by employees, even if you didn't specifically authorize their actions. In a general partnership, each partner is equally liable for the business's debts and the actions of the other partners.

For more information, call the closest Small Business Development Center. (SBDCs are often located at a university; consult your phone directory). Funded by the federal Small Business Administration, these centers are a great local resource for free information, business counseling, and classes related to all areas of business planning and management.

Another helpful Small Business Administration resource is SCORE (Service Corps of Retired Executives; call 1-800-634-0245 for the chapter nearest you). In addition to offering business start-up information and seminars, SCORE volunteers provide one-on-one counseling for current or would-be entrepreneurs. Says longtime SCORE counselor Harry Sumner, "We're happy to discuss all kinds of business issues, including the pros and cons of incorporation for your particular situation."

Types of Corporations

There are many different types of corporations. Each offers advantages and disadvantages in terms of taxes, paperwork, and legal obligations.

Since we don't have space to cover them all here, we'll look at four major types: C, S, PC, and LLC (see Table 20.2). Each is available in every state. It's also possible to combine these basic types to create a variety of corporate formats.

Table 20.2   Comparing the Major Corporate Formats

C Corporation: The Standard

The so-called C corporation is the standard format. As with all corporations, when you establish a C corporation, you create a separate legal entity with assets and liabilities that are entirely distinct from yours.

If a problem occurs, your liability generally is limited to whatever funds or other assets are actually owned by the corporation; your personal assets are protected. The C corporation format can have other advantages too, such as flexibility for structuring pension plans and other owner benefits.

The C corporation does have a major disadvantage: its tax status. If you own a sole proprietorship or partnership, you pay taxes once, because the Internal Revenue Service treats the company's profits as your personal income. If you own a C corporation, however, the corporation pays taxes on its profits, plus you pay taxes on any dividends that have been distributed to you.

C Corporation with Subchapter S Election ("S Corporation")

The S corporation offers the limited liability of a C corporation, but with a definite tax advantage: you can elect to be taxed for federal purposes as a partnership. This means that the income of your corporation is taxed as personal income only; you avoid the double taxation of the C format.

A C corporation must meet certain criteria to be eligible for subchapter S election. (Among the requirements: You must have fewer than 75 shareholders and offer only one kind of stock). If you can satisfy these and other criteria, the S corporation may be a better choice from a tax perspective.

Professional Corporation (PC, PA, SC)

A professional corporation (sometimes called a Service Corporation [SC] or Professional Association [PA]) consists of licensed professionals who provide a service, such as accountants, doctors, dentists, or attorneys. All states have passed laws allowing professionals to incorporate. While they remain liable for their own professional activities, the PC protects them to some extent from liability for the actions of others.

Limited Liability Company (LLC)

The LLC is a relatively new way to organize a business. Like an S corporation, the LLC offers the advantage of being taxed like a partnership. Multi-owner LLCs also offer the protection of limited liability.

If the LLC is a one-person enterprise, however, it is less clear whether this format limits liability to the same extent as other corporate formats. (Some states require an LLC to have at least two owners, although they can be spouses).

The LLC may be more risky, precisely because it is new. While there are legal precedents for many tax and liability questions involving C, S, and professional corporations, these issues remain to be decided for LLCs.

Says Dee: "Until more of the legal ramifications are worked out, I advise people to seek legal and other counsel prior to forming an LLC."

Which Format Is Best For You?

Ah, that we can't tell you; you'll need to decide based on your unique situation. This is a major decision and it's worthwhile to get legal advice.

Consult a qualified tax advisor as well. The various corporate formats are taxed differently and offer the possibility of different deductions. Your ultimate decision, such as the choice between a C or S corporation, may be determined by the tax repercussions.

Don't dismiss the standard C format too quickly, advises Chris Reid, an attorney with law firm Thompson Coburn. Some of his clients opt for a C corporation because they can establish an employee health plan with as few as two people (such as husband and wife). This allows them to deduct health insurance premiums.

Furthermore, a C corporation can deduct the salaries it pays to employees, which lowers the taxable income of the corporation. Depending on your situation, these perks may outweigh the C's tax disadvantages. The bottom line, says Reid, is "to do all the math" before making your decision.

"People think LLCs are more flexible because they're new, but this isn't necessarily the case," Reid adds. "While there's less paperwork for setting up an LLC, its operating agreement has to be fairly detailed. You have to spell out the company's rules, allocate profits, and say how you're going to distribute them. This is great if you want to be very specific, but it involves a lot of up-front work and many people just starting out aren't sure how they want to handle all these issues yet."

On the other hand, if you really want to lay ground rules, a detailed LLC operating agreement might suit you just fine. "It can be very appropriate for a joint venture, where you want to make sure each party understands its rights and responsibilities," says Reid. "It's also well-suited to enterprises involving several people, such as real estate or venture capital investments."

The Incorporation Process: What's Involved?

To incorporate, you pay a fee and file a document with the appropriate state agency, usually the secretary of state. (This document is often called the articles of incorporation, although the term can vary according to the type of corporation).

Keep in mind that corporate regulations, fees, taxes, and ownership rights vary widely from state to state. Many people choose to incorporate in the state where they live. On the other hand, if you will transact most of your business in another state, it may be best to incorporate there.

Make sure that your corporate name is not already being used by another company in your state. Check with the same agency where you file the articles of incorporation.

If you plan to do business nationally, you may want to see if anyone else in the U.S. is using the same company name. This involves arranging for a search of all state trademark registrations and all federal registrations and pending applications in the U.S. Trademark Office. For absolute protection in the U.S., you could register your company name, logo, or slogan as a trademark.

Be aware that an extensive search can cost anywhere from $500 to $1,000. "Usually I don't advise clients to do this initially," says Reid. "Trademarks are more of an issue if you plan to expand on a nationwide basis or open branch offices in other states."

Should You Consult an Attorney?

Is it possible to incorporate without hiring an attorney? Yes. Ken Jacobs incorporated TEK-WRITE three years ago through a Small Business Development Center at a local community college. Jacobs paid a (Georgia) state filing fee of $60, plus $40 to place the necessary announcement in the newspaper.

Not all communities have government centers that offer this service, but many have for-profit firms that will incorporate you for a flat fee. One such company offers a basic incorporation package for $158. If you're feeling expansive, you could try the deluxe package for $199 or create an LLC for $250. Additional options cost extra: $45 to elect S Corporation status, $35 to obtain a federal tax I.D. number. Other companies will let you incorporate online.

However, keep in mind that a qualified attorney can help you choose the best corporate format for your needs, answer questions, and manage the paperwork and other administrative chores. Since attorneys specialize, select one who specializes in corporate law and who is qualified to practice in the state where you want to incorporate.

"In my opinion, you should always discuss incorporation with an attorney," says Dee. "Every state has different laws, and it's difficult for a national company to generalize about the best way to handle your individual situation."

Agrees Sumner, "I'd be cautious about 'do-it-yourself' incorporation. A corporation is a state entity, and you could be getting standardized advice that doesn't take into account favorable or unfavorable aspects of the law in your state. It's worth the money to have a lawyer look over your incorporation papers."

Reid estimates start-up costs for creating a standard C or S corporation as roughly $500. Dee notes that some attorneys handle the incorporation process for a flat fee, usually around the same amount. Costs may vary from state to state depending on attorneys' fees. Incorporation costs are fully tax deductible, although they must be amortized over a five-year period.

Okay, You're Incorporated. Now What?

Regardless of how you incorporate, you will have certain ongoing responsibilities and expenses. Your state will require an annual registration fee ($50 to $100 in most states) and a yearly report on corporate activities. (This is a form which you or an attorney can complete).

You will need to file a "corporate minutes" document annually to summarize business activities for the previous year. Reid especially recommends documenting any unusual corporate transactions, such as taking a loan or making a major purchase.

There are also additional tax returns, which you can handle yourself or hire an accountant to complete. Many states charge a franchise tax on corporations with assets above a certain level. Fees for preparing tax returns are partially tax deductible.

Treat Your Corporation Like a Business

Suppose the unthinkable happens and you get sued. Is it possible for the lawsuit to tap personal as well as corporate assets?

While this can happen (attorneys call it "piercing the corporate veil"), it's rare. "Courts don't want to pierce the veil," emphasizes Reid. "However, they may have little choice if owners misuse the corporate format--deliberately performing an activity hazardous to the public, running the corporation as a shell, taking all the profits as personal income and leaving no assets in the corporation."

As a general rule, if you maintain scrupulous records and can document that you manage your personal and corporate affairs responsibly, your personal assets will be safe.

It's vital to separate your corporation from your personal life and maintain records that document the distinction. For instance:

• Open a bank account for your corporation, and keep its funds separate from your personal bank account
• Install a separate phone line for business use only
• Create corporate stationery, and use it only for business correspondence
• Maintain separate bank statements and accounting records for business and personal transactions
• Use corporate funds to make corporate purchases, personal funds to buy personal items

One caveat: If you borrow money, you may be asked to put up personal property as collateral or sign a personal guarantee to repay the loan. When you do this, these assets are no longer protected by the corporate veil. If you cannot repay the loan, your creditor can legally claim them. However (unless you've been doing things you shouldn't), the assets that remain in the corporation will still be protected.

"It's a Judgment Call"

Certainly, many sole proprietors operate successfully without incorporating. Consider Betsy Frick, who manages two businesses, Applied Instructional Design and Resumes from Scratch, with no plans to become an "Inc."

"So far, I just haven't found a compelling reason," Frick explains. "You have to weigh the advantages versus the disadvantages. Advantages might include appearing bigger than you really are, getting work from corporations that only hire other corporations, and gaining some tax deductions. Disadvantages include added administrative paperwork such as issuing yourself paychecks, holding board meetings, and filling out more tax forms; time to do all these tasks; and costs such as paying additional taxes, business phone line rates, business banking account rates, and so on. If I had employees, or if I were doing environmentally sensitive work such as cleaning up toxic waste spills, then I would certainly consider it. It's a judgment call you have to make for yourself."

Donna O'Leary-Abkowitz, a technical writer in Massachusetts, decided not to incorporate after consulting an attorney and an accountant. Both advised against it, she notes, because "this profession basically has low liability and the added costs to incorporating are not worth it." While she has encountered a few companies that will hire only incorporated contractors, this has not been a major obstacle. "The bottom line is, you have to dig deeper to find what you want," she says. "What else is new?"

To incorporate or not? It's up to you, and the decision is easier to make for some business situations than others. If you have partners or employees, it's probably wise. If you plan to stay solo, the advantages are less clear-cut.

Weigh the costs and benefits carefully. Since everyone's situation is unique, be sure to consult your own legal and tax advisors for guidance about your particular enterprise.

"Would I do it again?" muses Richard Schmidt, who incorporated his management consulting firm, RSA Ltd., in Delaware 11 years ago. "I don't know....Perhaps not, but then it seems nice to say that I head a corporation."

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About the Author
Alice E. Fugate, owner of Fugate Publications, has been self-employed since 1989 and considers it much more fun than working. Alice has published four nonfiction books, five test banks, and over 50 articles in magazines, newsletters, and web sites. As an editor, she has developed more than 35 leading college textbooks and nonfiction titles ranging from Accounting to Zoology. A contributing editor to Intercom Magazine since 1994, she pens "Minding Your Business," a column devoted to the joys and challenges of self-employment. Alice has taught courses for Washington University, the Association of Systems Managers, the Data Processing Management Association, and McDonnell Douglas Corporation. She has received awards from the National Quality Assurance Institute, Women's Commerce Association, and Society for Technical Communication.

I would like to thank the following people who generously provided information for this chapter:

• Jeff Dee, Assistant Director and Consultant, Small Business Development Center, St. Louis University
• Janet Poppen, President, Poppen & Associates, a full-service accounting firm
• Chris Reid, attorney with law firm Thompson Coburn, specializing in corporate law
• Harry Sumner, counselor for SCORE (Service Corps of Retired Executives)