A friend asked me the other day to write up a post about incorporating a business with circles and arrows. I eagerly signed up to do that because I was not thinking about writing a post. As I was writing the thoughts down, it would do justice to write about why I did what I did. However, due to the complex nature of incorporating with differing state regulations, I will give a higher level to incorporating. Remember, I am not a tax professional and this post is why I did what I did based off the research and some advice I received.
Incorporation
Incredibly high level, there are a multitude of reasons why you should incorporate. There are the following options with the IRS:
My Incorporations
All incorporations provide some sort of liability protection from your personal assets.
For me, I created two LLC’s and then finally created a C Corporation with some guidance from Matt and can only speak to those two. I created two single member LLCs for the tax year of 2014.
Originally, the idea behind incorporating a business is to take some thing to the bank and see if you could be approved for a business credit card. With the 2 LLC’s, I was approved for one Chase Ink Bold on one LLC EIN and a Chase Ink Plus for the other LLC EIN. One LLC was supposed to be for this blog. Then I created another LLC for all activities outside of the blog. Then I learned that all of the earnings from the side venture would be passed along to my personal income tax as a Schedule C. This is where I learned that if you incorporate as a C Corporation, all earnings will stay within the corporation until I am ready to take a distribution. That is when I decided that I have now rolled up all earnings from this blog and all outside activities into my corporation.
You may already be thinking, that there will be a double taxation. Yes, you are absolutely right. If you incorporate into a C Corporation, the income will be double taxed. Once on the corporation and once on your personal income tax. At a high level, there are some fancy, financial engineering tactics that you can deploy if you run a C Corporation. There was a thoughtful discussion about welfare and manufactured spending on the Forum. Along similar paths, it may be possible and requires additional research, but on the surface having a C Corporation you could change your income to match the criteria for some of the affordable housing in New York City. That type of financial engineering is beyond what I would ever do, but are interesting reads and thoughts.
Additional C Corporation Details
Think of a C Corporation as your typical large company that have many employees like Amazon, Google, FaceBook, Twitter, General Electric, Tesla, and many others.
If you are employed full time you also need to be cognizant of your employer’s code of conduct. I read through a lot company’s and here is IBM’s which I find to be very thorough. You can Google “<company name> code of conduct” and many of them will have similar language.
Personal Use of IBM’s Time
Whether or not your personal activity presents a conflict of interest, you may not conduct non-IBM work or solicit such business on IBM premises or while working on IBM time, including time you are given with pay to handle personal matters.
Say you worked at IBM, you can’t use the company time to do your side business even on vacation days. If you planned to use their mail room facilities to mail out your packages like reselling product or mailing out gift cards, they have right to open and inspect:
You should understand IBM has the right to inspect your use of IBM assets, including your communications using IBM’s assets. You should understand that IBM does not consider any such uses of its assets to be private. Therefore, you should not place or keep any personal items, messages or information that you consider private anywhere in the IBM workplace, such as, telephone, office, or email systems, electronic files, laptops, smartphones and other personal communication devices, lockers, desks, or offices. If you choose to do so, you should understand that IBM may at any time, monitor, recover through technical or other means, and review employee communications including emails from personal email accounts, records, files, and other items IBM finds through or in its systems, assets and any other IBM areas or IBM provided facilities, for any purpose. In addition, in order to protect its employees, assets, and business interests, IBM may share outside of IBM anything it finds, such as with its outside legal or other advisors, or with law enforcement.
Additionally, in order to protect its employees, assets and business interests, IBM may ask to search an employee’s personal property, including briefcases and bags, located on or being removed from IBM locations. If you use personal electronic devices for IBM-related work, then those devices may also be examined by IBM. You are expected to cooperate with all such requests. Employees, however, should not access another employee’s work space, including email and electronic files, without prior approval from management. For additional information on access to company property and employee personal property, refer to Access to Property & Information.
So it’s never a good idea to use the company facilities to do certain activities because explaining what’s in the box or what you’ve done on the Internet will put you in a jam. If they suspect you to be leaking information, they would open your outbound packages to see what you are trying to mail.
The inspections leads us back to the C Corporation. If, for whatever reason, your employer were to request to see your tax returns and you have an LLC, they could see you have a side business. If your side business was something like real estate, I don’t think there would be much of an issue. But if it was some other active income job, you will have some explaining to do. Having a C Corporation, nothing will be on your taxes until you take a distribution. However, you also need to be aware of the accumulated earnings tax (AET).
The accumulated earnings tax imposed by section 531 shall apply to every corporation (other than those described in subsection (b)) formed or availed of for the purpose of avoiding the income tax with respect to its shareholders or the shareholders of any other corporation, by permitting earnings and profits to accumulate instead of being divided or distributed.
Basically and generally speaking, you don’t want to hold on to too much cash in the business because the IRS may see that as sheltering the shareholder from taxes. If you decide to incorporate as a C Corporation, you shouldn’t run into the problem of the AET because at that point, your company should be making so much money that you could quit your day job. This accounting group has posted a great run down on the AET for you to read on.
Why I Chose A C Corporation Instead Of An LLC
There are many reasons and factors for someone to incorporate and this is just like every thing else we do, there is no cookie cutter solution for the masses. For me, I put into motion to incorporate as a C Corporation in 2015 with the end of my fiscal year after April 15 so my accountant has some breathing room to close out my books. The reason was to build up my “conglomerate” of side business activities where I have been spawning out of the blog. I also feel more comfortable taking out any side income from my taxes in case my employer or future employer wants to see it before I am ready to go out on my own.
True, all of this could have all be accomplished with one single member LLC, but I have grand visions for what’s coming up next as we continue to evolve in this hobby. More on this in the near future and hopefully it will make more sense for the decision to the C Corp.
Also apologies for those that caught a glimpse of the post this past weekend, accidentally published before I was finished.
Fascinating post. Please post more along these lines, as this is something I’d contemplating and any additional insight from you is greatly appreciated!
Thanks
No offense, but this is a complex matter and you didn’t seem to present any reason for your choice other than “big companies are C corporations too!”.
Are you aware that an LLC can elect various federal tax classifications, including C corporation? Read more at https://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/LLC-Filing-as-a-Corporation-or-Partnership. LLCs are generally simpler entities to operate with fewer state filing requirements and fees, though this varies by state. You’ll also want to research the state tax implications of such an election (e.g. you may need to file a state form to make the election).
Based on the limited information in your post and what I can infer, I find it unlikely the C corporation route is the best, but I acknowledge not having enough information to form a conclusion on that. The separation argument (not having any trace of the corporation on your personal tax return) may hold water, but there’s likely to be a large cost (in additional tax) to that.
If your tax advisor didn’t mention any of this, you should find another one (ideally a CPA or EA).
Thanks for the comment, yep it’s quite complex and lengthy. I wanted to build this out as a multi part series, but accidentally published on a Saturday (and didn’t realize). I took it down, expanded it a bit, and need to continue into areas like you’ve mentioned. But don’t quite have the bandwidth to do that as of right now as the semester is starting up again.
The C Corporation that I set up has a Fiscal Year ending in May and is incorporated in the great state of Wyoming.
Do you live in Wyoming, or does your business have (or intend to have) operations there (which means activity more substantial than just filing incorporation paperwork there)? If not, the corporation will need to register as a foreign entity in the state(s) it has operations in. That state, or those states, will impose the same taxes on your Wyoming corporation as they would on a local corporation. It’s rarely advisable for a small business to incorporate in any state other than its home state; all you’re doing is adding additional compliance requirements and costs.