Starting a new business venture is an exciting time full of hope and dreams. Unfortunately, the formation of a new business entity is also filled with complicated, bureaucratic formalities that can confuse and frustrate even the most experienced entrepreneur and add unneeded additional startup expenses.
When to Incorporate? One major expense that often arises when starting a new business are the legal fees associated with incorporating. One primary question that many entrepreneurs do not ask themselves or their partners prior to forming a corporation is, “Do we really need to incorporate?” Without any doubt, forming a corporation has many advantages, but is it a vital expense that is necessary when starting a new business?
The beginning of a new business venture is an experience filled with thoughts and emotions that it will grow into the next Apple or McDonald’s, but until that happens, do you have the money to spend on incorporating? More importantly, will your organization financially benefit enough to offset the formation expenses? Apple was in business for almost a year and McDonald’s was in business for over fifteen before they were formally incorporated.
Where to Incorporate? In addition to the normal expense for forming an entity, incorporating in the wrong state can also have a significant impact on your business. Different states have different tax benefits for incorporating in that state. Just because your business is physically in Minnesota does not mean you can’t incorporate in Delaware of Nevada where there are benefits may be more advantageous.
When to File for Incorporation? Another commonly overlooked detail is when to form an entity. Incorporating just before or on December 31 can be costly. For example, some states, California being one of them, requires all entities to pay an $800.00 yearly fee. I have seen clients come in December 30 wanting to setup an LLC before the December 31 and then after it was formed, they could not understand why they had to pay the state $800.00 when they were only in existence for 2 days. Furthermore, the company will have to go to the expense of filing tax returns for an entire year even though they were only in existence for two days. Remember, closing an entity is more complicated than opening one so it’s important to get it right the first time.
Compliance. Compliance of Federal, State, and local laws can also financially burden a business. If not found and resolved quickly, business and corporate compliance issues can be very costly to any organization regardless of size. Professionals, such as lawyers and accountants, who usually bill their time by the hour, derive a significant portion of their income from answering questions and fixing mistakes or “messes” made by their clients. Many of these mistakes can cost a client hundreds if not thousands of dollars. What makes matters worse is that so many of these costly errors could have been avoided with some forethought.
For example, many of us drive our cars for business purposes and deduct the gasoline, maintenance, etc. for the car. However, if the vehicle is not properly titled in the name of the business, the tax deductions could be disallowed. Your CPA or tax attorney will spend a time reviewing the latest case law or IRS regulations looking for a strategy to get the deduction. All the time expended by your attorney or CPA is usually billed by the hour and could have been avoided had the vehicle been properly place in the name of the business from the outset. Most attorneys and CPAs will tell their clients that it costs a lot less to prevent problems than it does to fix them.
Other legal and tax expenses that can be avoided are:
Annual Minutes: Not preparing these can be a real issue as annual minutes are reviewed by other parties for business loans and other activities. No minutes? No loan.
Loan Documents: One benefit to owning a corporation is the concept of loaning money to a shareholder as a tax strategy. This is a perfectly legitimate corporate benefit, but if the corporate documents to do not accurately reflect the loan, the IRS could disallow the loan and convert that money into taxable income.
Timely Filing of All Documents: Failure to file everything from taxes to various Federal and State government reports can be very costly and you may also incur penalties for late filing. Again, this is east to avoid.
The formation of an entity is a process that can be confusing, arduous, and costly if not handled properly. Don’t rush into it lightly or recklessly. Using the services of a company like Legalzoom or other companies may only impede your decision and cost you more in the long run. Do your own due diligence and seek the guidance of a licensed attorney and CPA before you form any entity. The money you invest in their time should save you needless headaches and let you focus on the future and not wasting time cleaning up the past.
[NOTE: Thanks to Michael S. Duell for this guest author contribution. Mr. Duell is the Director of Business Operations at Ruyle & Ruyle, a firm that includes small business corporate law as one of its specialities. If you are looking for a good boutique law firm that caters to small businesses and startups, consider Ruyle & Ruyle.]