What your accountant forgot to tell you

Too many accountants confuse business owners with the cost of tax compliance for additional entities without understanding the long term legal benefits and protections that are provided to the owner’s business and personal assets.

Quick, what type of entity structure do you use for your business? C-Corporation? S-Corporation? Is it the best one for you? Whose advice did you seek to help make this vital business decision? Do you realize the potential personal risks of running your business?

Perhaps the most important decision you make as a business owner, a decision that should be made only after consultation with a qualified group of legal and tax professionals, involves the legal entity structure of the business.

The choice impacts the amount of tax that will be paid over of the life of the business, the after-tax “take home” compensation you will realize during your lifetime, the ability to maximize personal enjoyment of tax friendly fringe benefits and retirement funding and deferred income that can be utilized after you exit from the business. It is certainly a decision that should not be taken lightly. Do you remember the discussions you had with your accountant, your attorney, and other mentors and trusted advisors to assist you in such an important decision?

Unfortunately, most business owners permit their accountant to make the decision unilaterally. If and when the business becomes involved in litigation, the result could devastate the economic well being of you and your family. You must proactively prepare. A lawsuit is filed every thirty seconds – more than 90 million are filed in the United States each year. Are you prepared to survive one? You can almost see the dollar signs in the litigator’s eyes when they find the deep-pocketed business person that has left business and personal assets exposed. At that point, it’s too late.

My advice is simple–make a better decision. Make a decision that will create opportunities and benefits while at the same time reduce personal liability and minimize risk. It’s actually easier than it sounds. The genius is producing the simplest structure that provides the maximum benefit. The three most important aspects of the decision are tax, liability, benefits and compensation.

What are your options? You can operate as an S-Corporation, a C-Corporation, a Limited Liability Company (LLC), a partnership or a sole proprietorship.

Operating as a sole proprietorship or partnership offers no personal limited liability protection and very limited opportunities for tax, compensation and benefit planning for you the owner. The S-Corporation is a very popular choice because of the potential for personal limited liability; however, owners have limited fringe benefit opportunities. The C-Corporation initially provides a lower tax rate, the possibility of double tax—at both the corporate and individual levels, but the best advantages for owner fringe benefits and pre-tax corporate funding of income deferrals for retirement and future income streams. The LLC represents a newer entity form in which case law is still evolving. As such, operating your business as an LLC might not protect the owner’s assets. States have allowed adverse parties to attack personal assets in certain situations. A clear disadvantage is that LLC members are subject to self-employment tax for social security and Medicare. Business owners have the potential for doubling ofthe payroll tax if they also receive wages from another company.

So what’s the best choice to operate your business? Unfortunately, there is no one size fits all answer. The choice of entity depends on the state the business operates, type of business conducted, type of assets held by the business, flexibility for growth or the addition of other lines of business, and the owners plan to exit the business and provide a long term income stream.

The best answer, in almost every case, incorporates a multi-entity structure that allows for the utilization of different entity types. From a legal perspective, an incorporated entity such as a C-Corporation or an S-Corporation offers the same benefits. The real differences, and therefore the real opportunities, are defined and found in the tax code. The tax code created theses entities and any analysis of the tax benefits must consider the advantages and disadvantages of each. A multi-entity structure using both a C and S-Corporation, for instance, with proper management, can allow you to benefit from the advantages and avoid the disadvantages.

The ultimate goal for any entity structure should be to provide personal and business assets, minimize tax, maximize take home dollars and maximize pre-tax corporate funded benefits for you and your employees.

It must be pointed out that simply incorporating will not protect your personal assets. You must have an understanding of the necessity to comply with corporate formalities. If you are not respecting the corporate entity, an adverse part will not be forced to respect it either. This is what permits that hungry litigator to pierce the corporate veil and satisfy claims against the business with personal assets. Of course the business must have separate bank accounts, but you also must ensure that business money, personal money and assets are not commingled. You must also ensure timely corporate meetings and keep corporate minutes up to date.

Don’t be dissuaded by short term expenses that are offset by long term benefits. Too many accountants confuse business owners with the cost of tax compliance for additional entities without understanding the long term legal benefits and protections that are provided to the owner’s business and personal assets.