August 31 02 SBC Small Business Newsletter

August 31, 2002

Table of Contents

Staff Article - CHOOSING A FORM OF ORGANIZATION
Staff Article - HARNESS THE POWER OF A STRONG VISION
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Staff Article

CHOOSING A FORM OF ORGANIZATION

by: Cary Christian

I was posting a comment to a business organization thread on the Internet Marketing Warriors forum earlier tonight, and realized this is an area where people harbor a lot of misconceptions that can cost them a lot of money. Since I don't want to see any of you wasting money, I thought I would address the issue here.

I apologize in advance to those of you who reside and work outside the U.S. This article addresses issues, primarily tax issues, related to U.S. business organizations only.

Many people opt to incorporate their business without really giving much thought to how they should be organized. This can create a considerable number of problems down the road. It is an issue that not only deserves, but requires a full understanding of how your choices will affect you in the years to come.

YOUR INCORPORATION OPTIONS

There are basically three types of corporate form you can select from. The first type is the regular corporation. The technical term for a regular corporation is "C Corporation" because it is taxed under the provisions of Subchapter C of the Internal Revenue Code. The corporation is organized under the laws of the state you choose, normally the state in which you live. The regular corporation is a separate legal entity that files a tax return (Form 1120) and pays tax on its taxable income.

You may choose to have your new corporation taxed under the rules of Subchapter S of the Internal Revenue Code. This is the second type of corporation: the S Corporation. An S Corporation must also file a return each year (Form 1120S). The taxable income of the S Corporation is computed on the return, but the S Corporation is not subject to income tax. Instead, the income of the corporation is allocated to its shareholders who report their share of the income on their personal returns on Schedule E. Most people almost automatically make the S Corporation election to avoid the double taxation of earnings that can occur in the Regular Corporation scenario.

The third option is the Limited Liability Company (LLC). An LLC is actually a fairly new "hybrid" organization that shares characteristics of both a corporation and a partnership. It is included as an incorporation-type option because it limits the liability of its shareholders in much the same manner as a corporation does. Like an S Corporation, the LLC does not pay tax on its taxable income. The income is passed through to the shareholders who include the income on their personal returns.

WHICH FORM OF "INCORPORATION" IS BEST?

Regular corporations (C Corporations), S Corporations and LLCs all provide you with protection against personal liability. S Corporations and LLCs eliminate the concept of double taxation of earnings that you find in regular corporations since the income of the S or LLC passes through to the shareholders. In a regular corporation, the corporation pays tax on its earnings and there is the potential of taxation again at the individual level if you take out earnings in a non-deductible way, such as by paying dividends.

However, you have to remember that corporate tax rates are lower than individual rates on taxable income up to $75,000, so if you plan to leave profits in the business for awhile, it might be worthwhile to organize as a regular corporation.

There are also many ways to defeat double taxation in a regular corporation environment as long as you have the ability to perform effective yearend tax planning BEFORE yearend.

So, it is not a given that it is always better to go the S Corporation or LLC route, but . . . it usually is. They are much simpler to manage for most people.

If you are the sole owner of the entity, an LLC will probably be the easiest to manage since you report the income from the business on your Schedule C just as you would if you did not incorporate. If you are not the sole owner, the LLC will file a partnership return (Form 1065) and you will receive a Schedule K-1 each year telling you what income to report on your personal return.

If you have other owners in addition to yourself, an LLC gives you more flexibility in distributing cash flow and profits.

For example, assume you own 90 percent of the stock of the company and another individual owns 10 percent. However, for valid reasons your agreement is that the other shareholder will get 50 percent of the profits. You can handle this type of situation easily with an LLC. A particular shareholder's share of profits, cash flow and taxable income or loss do not have to coincide with ownership interest.

With an S Corporation, however, all distributions and allocations of taxable income must be made in accordance with stock ownership percentages, so there is very little flexibility. In this example, you could have one terrific tax mess to deal with if you were organized as an S Corporation but had to distribute profits and cash flow based on something other than stock ownership percentages.

BOTTOM LINE?

Unless you fully understand the rules and the implications of your decisions, you are going to need professional help. There are so many variables involved in making this decision that it becomes quite easy to make a devastating mistake. You must not only consider your business and your plans for running it. You must also consider your personal tax situation, the tax positions of other owners, the possibility you will be bringing in additional owners in the future, and a wide variety of other factors.

People tend to shy away from hiring attorneys and CPAs to help them with organizational issues because it can become quite expensive. Don't cut corners! Get the help you need and do it right from the beginning. Your savings over time will greatly exceed the cost.

These are just a few of the issues you will encounter, but based on these alone you should be able to see that this is a choice that requires a good deal of thought and some professional assistance. If you've already chosen a form of organization and believe you made the wrong choice, don't despair. There are provisions that you can use to reorganize your business organization tax-free and get it into a form that works better for you. Just get the professional help now that you should have gotten in the beginning!

Copyright (c) 2002

Guest Article

HARNESS THE POWER OF A STRONG VISION
by: Wendy Hearn

What is your vision? How is this vision communicated to inspire you and your organisation? You don't have a clear and powerful vision? Join the club. When I'm working with individuals, I've noticed that generally they fall into two distinct categories regarding having a strong vision. Either they've never really had the opportunity to understand the concept of having or defining their vision. Or they have a vision statement because they think they 'should'. Remember, 'shoulds' represent other people's expectations and therefore not things to which you a personally committed.

The one thing I've noticed in my work is that very few individuals or organisations really harness the power generated by a strong vision. Clear definition of your vision acts as a magnet to pull you forward in the direction you truly want to take. Your vision provides inspiration for you and, if communicated well to your team or organisation, inspires them too.

What do you refer to when you want to make decisions, when you have to decide which opportunities to say 'yes' or 'no' to, or which direction to go with your business? When you have a strong vision in place and refer to it regularly, it helps to resolve the conflict which can occur within you.

Teams or organisations who have a powerful vision, inspire individuals to pull together. It's so much easier for everyone when they all know clearly where they're heading.

Many organisations publish mission statements but often, these hold no real meaning for the individuals within the organisation. A strong vision and a clear mission statement go together like 'bread and butter'. The components of a mission statement stem from having a clear vision to start the process. Individuals and organisations can define their mission and purpose with more meaning and clarity if they are provided with a powerful vision. A strong vision challenges people to achieve more and encourages them to think 'out of the box'. It inspires you and the people you work with.

Your vision is unique to you and will vary from individual to individual. It propels you forward naturally, rather than relying on motivation alone, which doesn't usually last. A vision helps to keep you on track and focused on where you're heading. What I want for you is a vision which grabs you so strongly that it stretches you way beyond your current
position. I've found that with a strong vision there isn't the need to strive so hard and the energy required doesn't drain you so much. It allows you to focus on your achievements in the present because a vision doesn't have an end which you reach, like a goal. The energy generated by a vision is much healthier and requires less of a struggle. A vision draws on your natural energy which comes from within you because this is where your vision sits. When aligned with your values, a vision and a mission statement feel truly yours and right for you. In short, a perfect fit.

If you have a vision for your organisation, I encourage you to consider this. If 3 of your top employees were asked to share your vision, would they be able to? If not, what would it take to communicate this throughout the organisation? What benefits do you see for your employees in clearly understanding your vision?

Many times, people say "I wish", but unfortunately wishing alone rarely makes things happen. However, a strong vision can really accomplish a great deal, and often more than you'd dared to dream of.

What I want is for you to define a strong vision and a mission
statement. Are you ready to do this?

--------------------------------
Wendy Hearn
Personal and Professional Coach

She works with business owners, professionals, executives and
managers who are ready to enrich their lives. . . finding more
success, fun, balance, joy and time. She coaches one-to-one with individuals and groups by telephone and email.

http://www.Business-Personal-Coaching.com
mailto:wendy@Business-Personal-Coaching.com

Copyright 2002, Wendy Hearn. All rights reserved.

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