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Should I Incorporate My Mediation Business?

Incorporating sounds like something reserved for big business, but it offers a couple of perks for small businesses, such as mediation businesses, both legally and financially:

  • Legally: Incorporating establishes your business as a separate legal entity and provides some protection for you personally from any contract-based lawsuits filed against the business.

    Incorporation does not, however, protect you from personal liability for negligence in the performance of your services, because everyone is legally liable for his own conduct that constitutes a civil wrong (a tort) resulting in injury to other people, whether he’s acting on behalf of a corporation or not.

  • Financially: Setting up a corporation enables you to pay yourself as an employee of the corporation, which may significantly reduce your self-employment tax.

Now the bad news: Running the corporation adds to the paperwork and hassle of conducting business. You need to have an annual corporate meeting, complete with meeting minutes; to issue at least one share of stock; to file with the IRS for an employer identification number (EIN) so you can issue paychecks to yourself; and other such nonsense.

Consult your tax advisor and attorney to weigh the pros and cons of incorporating and to determine the best way to structure your business:

  • Sole proprietorship: With a sole proprietorship, you don’t incorporate. This is usually the most attractive option for consultants and freelancers who don’t have employees working for them, because it is, by far, the easiest route. This option has two main drawbacks:

    • You have to pay double the Federal Insurance Contributions Act (FICA) taxes. In other words, instead of paying about 7.5 percent in Social Security, Medicare, and Medicaid, which is what you’d pay as an employee (with your employer paying the other 7.5 percent), you pay the entire 15 percent as a self-employment tax, at least on the first $100,000 or so of income.

    • A sole proprietorship offers no legal protection. If someone sues your business, they’re suing you.

  • S corporation: An S corporation is one of the most popular choices for individuals who choose to incorporate. Like a limited liability company (LLC), it provides some legal protection of the owner’s personal assets. Perhaps more importantly, it reduces the amount of income that’s subject to self-employment tax. Here’s how that works:

    You take half of your income as salary and half as distributions. On the half you receive as income, the corporation pays half of your FICA and you pay the other half. The half you receive as distributions is not subject to FICA, so you essentially pay self-employment tax on only half your total income.

  • Limited liability company (LLC): An LLC is sort of like an S corporation but in most cases is better for partnership-owned businesses. Potential benefits over other types of business structures include the following:

    • An LLC provides some legal protection for your personal belongings; that is, if someone sues your business, theoretically they can go after only your business assets, not your personal assets, such as your home. In practice, however, most people who sue, sue the business and its owners. Still, if managed properly, an LLC provides more legal protection than does a sole proprietorship. (A C corporation provides more legal protection.)

    • Owners of an LLC may distribute profits as they see fit. With an S corporation, profits must be distributed according to the ratio of stock ownership, so if your partner put up 70 percent of the money to start the business, he gets 70 percent of the profit, even if you’re doing 70 percent of the work and he’s contributing only 30 percent of the work.

    • Income passes through the LLC to the company’s members, so the company doesn’t pay taxes on it, which avoids the double-taxation issue that C corporations must deal with.

    A major drawback of single-member LLCs as compared to an S corporation is that all of the money paid out by the LLC to its sole member is subject to self-employment tax. For multi-member LLCs, a major drawback consists of complications in dealing with tax issues.

    Multi-member LLCs have to file a return of partnership and make sure its members get a form K-1. The partners then file a Schedule E. If you go the multi-member LLC route, hire an accountant with experience in handling partnership tax issues.

    If you establish a multi-member LLC, you should have an operating agreement in place that spells out everything from operation and management to distribution.

  • C corporation: C corporations are primarily for large businesses or for startups that eventually may need to go public or attract venture capital. In other words, you probably don’t want or need to structure your business as a C corporation.

  • Partnership: A partnership is like a sole proprietorship, except that the business is owned by two or more people. Like a sole proprietorship, a partnership offers the owners no legal protection. Although you can set up a partnership through a verbal agreement, you should consult an attorney to have the partnership agreement written up in detail, including what happens in the event that you choose to dissolve the partnership.

However you choose to structure your business, you should consult with an attorney and an accountant who has experience with small businesses. Your attorney and accountant can help you choose the best way to structure your business, generate the necessary paperwork, and handle the details of processing payroll and distributions if you choose to form a corporation.

Some businesses, including The Company Corporation, specialize in structuring small businesses as corporations. They can help you obtain the required licenses and permits, write bylaws and operating agreements, register your business name, and obtain an Employer Identification Number (EIN), which the corporation needs to pay its employee — you.

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