Is the Cost of Incorporating Really Worth It for Your Small Business? | USTaxAid

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Is the Cost of Incorporating Really Worth It for Your Small Business?

Written by Diane Kennedy, CPA on October 13, 2019

Is the cost of incorporating really worth it for your small business? Or, for that matter, is the cost of forming a business structure really worth it for your real estate investments?

Only you can determine how much risk you want with your business. But, there is such a thing as avoiding unnecessary risk. And, as usual, there is a cost to doing that. That’s where you need to weigh the risk and reward of a certain action. It is the reward greater than the risk or cost?

I run into people all the time who tell me their businesses is too small and it doesn’t make sense for them, tax wise, to incorporate. That’s because the amount of self-employment tax they pay is small. Although I often sell the idea of forming an LLC or corporation for business because of the huge tax savings, an even more important reason why they are best is because of asset protection. If you don’t have a properly set up and run business structure for your business, all of your assets, business and personal, are at risk in the case of a lawsuit.

Is insurance enough? Well, if you own your own home, it is possible to get an umbrella policy to cover the risk that would involve an unincorporated business. But, it’s very difficult to get liability insurance for business unless you are really running it like a business. That means a business structure.

So, if you don’t own your own home you may not have any other option. You can’t get insurance and so you either put everything at risk or you form an entity.

I strongly suggest you form an entity.

A landscaper was sued by a homeowner whose house flooded. The problem was that the house was in 100-year flood area and they were unlucky enough to have that hundred-year flood that flooded their house.

The landscaper was likely not at fault for anything he or his crew did. A lot of places flooded in that time. But, theproblem was that the homeowner insurance didn’t cover the flood because they didn’t have the special flood insurance. So the owners wanted someone to cover the damage to their expensive home. The jury agreed and awarded the couple $1.4 million. The landscaper had a sole proprietorship but he also had insurance. His insurance cover $1 million, which was the limit on the policy.

The additional $400,000 needed to be paid by the landscaper. He didn’t have it, but that didn’t stop them from taking everything he had and forcing him intobankruptcy, which also cost him his business.

If he had been in a properly set up legal entity that was being run properly, the liability would have stayed just with the business. He might’ve ended up with a lawsuit anyway but they could all only get the amount of the insurance and whatever assets happened to be inside the landscaping business. They couldn’t take his kids college fund, his savings account, their house, his wife’s jewelry and all the other things they took away in that lawsuit.

If you asked him today whether a business structure is worth it for a business, what do you think he would answer?

A client of mine had an apartment building. He was so proud of it because it was his first big real estate investment. It took every dime he had to buy it. In fact, he didn’t have any money left over to form the LLC to hold it. That was okay, he reasoned, because he had liability insurance.

One day he was driving and heard that there was an escaped fugitive. He was armed and dangerous. My client got a call just after he heard the radio announcement. It was the property apartment manager. He had a dilemma. Someone had seen who they thought was the fugitive in the elevator with them. He had gotten off on the floor and gone into an apartment where a single mother lived. The other tenant had never seen the man before and she was worried for the single mother.

He turned his car around and headed right there. His apartment manager had called the police, who were already there. They talked to the tenant/witness. She seemed credible. The police went with him to the single mother’s door.

They knocked on the door and announced who they were. There was no answer. They knocked again. They heard a baby cry who was quickly shushed inside.

And now the police had a dilemma. If they broke in, there was a good chance that the baby and the woman who lived there would be in danger. They knew that the escaped fugitive had a history of violence. And they knew he had a gun.

That’s when my client said, “I have a key.”

He gave the key to the police who were able to quietly come into the apartment and secure the scene quickly. It turned out that the man was the woman’s new boyfriend. And for whatever reason, they didn’t want to answer the door. He wasn’t the escaped fugitive.

A month or so later, my client got a letter from a lawyer. He was being sued for millions of dollars for violation of the landlord tenant act. He did not have the right to give the police access to the apartment.

That wasn’t fun, but he knew he had very good insurance. So he gathered his information reports, reported it to his insurance company and they all met altogether.

There was the lady who lived in the apartment and her attorneys. There were the attorneys for the insurance company and then there was him. It didn’t take him long to realize that the lady and her attorney wanted to prove that he was wrong. But what he didn’t realize is that the insurance company lawyers also wanted to prove that he was wrong and in violation of the terms of the insurance policy. In other words, they were there to protect the interests of the insurance company and not protect his interests.

In the end, he had to get his own lawyer because he was not only defending against a lawsuit from the tenant, he was defending against the allegations by the insurance company.

He survived that. And the next thing he did was form an LLC to hold the building. He had learned that insurance isn’t always all that it’s promised to be.

If you have a business or are thinking about one or you have real estate investments or are thinking about them, Iurge you to consider how much risk you really want to take.

You could say, well, I have nothing to lose. Let them go ahead and sue. If that’s the case, just be prepared for defending not just now but against a judgment against all of your future earnings. It takes a comprehensive asset protection plan to be sure you protect yourself not just for now but in the future. At a minimum, form an LLC. If you really can’t afford that for your business, wait to start your business. In my opinion and from what I’ve seen over the years, the risk can be just too great if you start without the protection you need.

We don’t form business structures in my company. We can help you with some referrals though, so please let me know if you’d like one.

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