Legal and Tax Considerations of Setting up Your Own Business
By Eric Jahnsen
Setting up your own business is not that difficult and it is really not necessary to
pay someone to do it for you if you are relatively computer literate and savvy. However, before
proceeding, there is something you should know about incorporating; the most significant reason
to incorporate is liability.
If you own a store on a strip mall and a customer could walk in the front door, slip and fall,
injure themselves and wind up with mountainous medical bills then yes, you have a liability
issue and you need to be incorporated. But what if you are just inputting medical records on
your home computer? Where is your liability? If you wanted to, you could get errors and
omissions insurance for any inputting mistakes you might make. In that situation there really
is no liability issue.
With that said, there are other reasons you may want to incorporate. Many businesses do
not want to enter into contracts for services or material with an individual, rather they want to
deal with other businesses. You may be in a situation where the company you work for will not
deal directly with you but they will sign a contract with your business. Then you need to be incorporated.
You may have financial backing lined up for a venture but the backers will not fund a person,
only a business. Then you need to be incorporated. There are other reasons to incorporate, but
the fundamental issue you face is the fact that your tax situation becomes much more
complicated and expensive after you have incorporated. And that complication and expense can
be justified only if you do it correctly: if you incorporate correctly and conduct your business in
the "proper fashion."
The problem you face is summed up in the term "pierce the corporate veil." Here is what
happens; you incorporate, you conduct your business in the "proper fashion," you do everything
correctly, as far as you can tell, and then the unthinkable happens and a liability event occurs.
The liability event is significant enough that lawyers become involved and the whole thing winds
up in the courts.
During the proceedings, the defense attorneys will try to "pierce the corporate veil." They
will force you to prove that you conducted your business affairs in the proper, legal fashion
by demanding to see:
1. Your Employer Identification Number (EIN) assignment letter from the IRS
2. Yyour Articles of Incorporation (or Articles of Organization if you are a Limited Liability Company - LLC)
3. Yyour Form 2553 election to be considered a small business corporation by the IRS
4. The IRS' letter approving that election
5. All of your business tax returns, for each year the business existed, showing compensation of officers
6. Your personal tax returns for those same years showing inclusion of that business income
7. All of your filed, state-required, yearly annual reports
8. Your county and municipal tax receipt numbers or tax registration numbers or certificates proving
that you are legally registered to conduct your business at your location and
9. Last but not least, your business checking account showing that all of the income from the business
was deposited in to that account and all of the business expenses were withdrawn from that account.
If you fail any one of these tests, or cannot provide one or more of these documents,
the defense lawyers will have done their job; they can then declare that your business is not
legitimate, you did not conduct your business in the "proper fashion," the "veil" of business
liability protection has been "pierced" and you are now personally liable for all of those
mountainous medical expenses.
That is what you face. So you have to make a decision; since you are going to go down
the incorporation path, do you want to do it correctly or not? After spending all of that extra
money and suffering all of that extra complication in order to be incorporated, do you want
to do the job correctly or not? Sure, you will probably never need to prove it, but you have
to spend the money anyway so why not do it as best as you can? If nothing else, just to
know that you could prove yourself to a higher authority like a court of law.
Let's rank business categories from a tax point of view. The easiest is a Schedule C
for Self-Employment Income, included right along with your tax return when you have a business.
When your self-employment income is high enough, a Schedule SE is generated automatically to
pay your Social Security and Medicare taxes. You do not even need an EIN. By far it is the
easiest and least complicated.
And a note about tax years; it is best to have a calendar year tax year. Fiscal tax years
should be used only if there is an over-riding business reason. The vast majority of the tax
preparation profession is geared up for calendar year tax payers and businesses, so staying
in that cycle is beneficial from a business-support point of view.
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