Business Structures (continued)

Corporations

Becoming a corporation may seem a bit hoity-toity for a creative. It conjures up visions of monolithic, heartless companies that prey on small businesses. But this isn’t the case. Even the smallest of businesses can be a corporation, though it does require more thought and can be more expansive to set up than a sole proprietorship or partnership.

That said, a corporate business structure does offer you more protections, in part because a corporation is considered an independent entity, separate from its owners. As such, any debt belongs to the corporation, not the owner, so your personal assets aren’t on the line if things go wrong. Profits can also be retained by the business and not directly reported onto your personal taxes. You can even issue stock, though there are limitations based on the type of corporation you are – a C or an S.

The downside of a corporate structure is increased paperwork and regulation. Before you incorporate, you’ll want to discuss all the ins and outs with a tax expert, accountant or attorney. In Washington, you incorporate through the Secretary of State’s office. You will need to file the required articles of incorporation and bylaws that outline specific activities, such as when your annual meeting will occur, how officers are elected, their terms, etc.

S Corporation

An S-Corp is a good choice for many small businesses. It offers the additional tax benefits and liability protections a larger C-Corp enjoys. Income and losses are passed through to the shareholders (including you) and reported on individual tax returns. Personal assets are protected as an S-Corp as it is considered an individual entity that is separate from its owner. Instead of taking draws from the business as you would with a sole proprietorship, the corporation pays you via a paycheck. You are, in essence, an employee of your business, even though you are its owner as well. This differentiation is important if you plan to secure financing for a new home or car. A lender is much more likely to look favorably on an application if you receive a regular paycheck instead of paying yourself a draw from the business.

I learned this the hard way. I tried to buy a home at least three times when I owned my business, and it was a sole proprietorship. It wasn’t until I incorporated as an S-Corp that my loan sailed through the underwriters and application process. My credit hadn’t changed, my business wasn’t making more money than it had been, and my salary was still the same. I had become less risky to the lender primarily because I was getting a paycheck instead of drawing money from the same bank account. It doesn’t make sense, I know, but it is the way the financing and lending world works.

Because they have to follow the same rules as larger C Corporations, there are more filing requirements, including holding an annual meeting, maintaining minutes and voting on major corporate decisions.