Tim Foster

Tuesday, 23 November 2004 09:06

Night terrors

Are taxes the No. 1 problem that keeps business owners up at night? No. Taxes may get you frustrated, but they shouldn't be the leading reason why you can't get that solid five hours of sleep. However, we will talk about how reducing taxes to the legal minimum can gain you an advantage over your competition.

Instead, I'd argue that the most commonly overlooked mistake of closely held businesses is their legal entity structure. It is amazing the number of sole proprietorships and single entity structured business that exist today.

Unfortunately, we live in a very litigious society. Everyone is suing someone. Business owner frequently become targets because they are perceived to have deep pockets.

Doesn't the incorporation protect me?

Assuming the ownership group follows the prescribed corporate formalities, the owner's personal assets are protected. Liability is limited to the business owner's investment in the company.

But don't be too quick to assume that corporate formalities are being followed to the extent necessary, because most business owners aren't doing so. If you're incorporated, are you having shareholder meetings? Are you careful with cash flow to avoid commingling personal and corporate funds?

If the answers are no, you risk losing personal assets. If you are not respecting the corporate entity, it's unlikely that a court will not force an adverse party to treat it as such.

Even if you are respecting the corporate entity, don't stop reading here. Business owners operating as a single incorporated entity are not as protected as they should be. Conducting operations and holding business assets in the same entity creates an opportunity for a successful litigant to satisfy claims with business assets. Even if fully depreciated and seized and sold for scrap value, to maintain a viable business, the owner faces replacement costs at a difficult time for the business.

Is insurance the answer? Unfortunately, insurance is a safety net with holes large enough to fall through. True asset protection is afforded only with proper entity planning. It's the reason big corporations have a seemingly endless array of operating companies, holding companies, employee leasing companies and asset leasing companies.

The trick is finding the right level of complexity for your business; don't make the structure 1 percent more complex than necessary.

Choice of entity planning

It's a rarity when a business owner has a response to the question, "Why are you an S-Corp, C-Corp, LLC or sole proprietorship?" As accomplished as business owners may be in their niche area, they are likely baffled by the complexity of the 1.5 million-word tax code and regulations. But opportunities are buried deep within those many confusing words.

Choice of entity planning has far-reaching implications and could mean the difference between surviving a lawsuit or even being sued in the first place. The key is twofold -- the planning approach must be both comprehensive and proactive.

Closely held businesses must take a comprehensive approach to corporate and personal tax planning, retirement, succession, estate, educational, choice of entity planning and benefit planning. You can't simply place a Band-Aid over one of the problem areas. A failure to properly plan in one area may offset savings or efficiencies in others.

Planning also results in tax savings. To minimize tax obligations, a business must be sure that every expense of the business becomes a tax deduction, now or in future years. The way a deal is structured, the way a contract is worded or how an expense is described can mean the difference between something that is deductible and something that is not.

Entity structuring and tax planning provide business owners an opportunity to create and maintain a competitive advantage over their competition.

Tim Foster is a tax services director with International Profit Associates. IPA's 1700 employees offer consulting services to businesses throughout the United States, including Alaska and Hawaii, as well as Canada. Reach him at (847) 808-5590 or at www.ipa-iba.com.