Freelancer’s Survival Guide: Incorporation
Artwork donated by Pati Nagle.
The Freelancer’s Survival Guide: Incorporation
Kristine Kathryn Rusch
I spent most of this evening putting another Freelancer’s Survival Guide Short Book together. The first short book, When To Quit Your Day Job, is available now in an electronic edition. It’ll be on all the sites eventually, but right now, you can get it on Smashwords (in any e-format).
What I’m doing as I put these short books together is setting up the sections for the final Freelancer’s Guide—all 150,000 words of it. Those of you who have donated will get the big book (unless you e-mail me with requests for the shorter books as well), and that should come to you sometime this fall.
Things are coming together, which feels quite good.
Because I’m organizing, I’m also going over my topic list. I’ve missed a few things as specific topics, but I’m discovering that they were covered in brief in other posts. One of the missed topics is incorporation.
I’m in the middle of another novel, which makes me very spacey, and that means my desk is piled high with papers. I’ve gone through them twice tonight, and can’t find the initial letter asking me about incorporation. (Sorry!) I know it’s here somewhere, but rather than wait to locate it, I’m just going to dig into the topic.
I agonized over writing about incorporation and twice crossed it off my list. I am not a lawyer, nor am I a tax expert. I really didn’t want to tackle the topic. But I talked with a few people about whether or not I should write about incorporation, and all of them seemed enthusiastic.
A few suggested I contact my “panel of experts” to discuss incorporation. While I know dozens of attorneys, many of whom are tax attorneys or copyright attorneys or corporate attorneys, I don’t feel right asking them to comment for this article.
I know what they’ll all say. It depends on the business. It depends on the financial situation of the business. It depends on the structure of the business. It depends on whether or not you want investors, what your tax liability is, and what it might become.
It depends, it depends, it depends.
It also depends on which country you’re in. Since I’ve received donations for the Guide from Japan, England, the Netherlands, and Canada (to name only a few), I don’t want to spend a lot of time on a topic that I know only from an American perspective.
So I’m going to handle this very complicated topic in a very simple manner.
First, let’s discuss business structure.
Most freelancers are sole proprietors. They run their own business by themselves. They own it, they run it, and they manage it alone. They file a Schedule C on the United States tax form. They use a simple accounting system. Often their business doesn’t even have a name, except their name. People in the arts work this way, often. So the tax document is filed under the owner’s name. Business cards have the freelancer’s name on them, and maybe a description of what the freelancer does.
That’s it. Simple and easy. For most of you, this is a fine system. No need to mess with it.
But let’s say you decided to name your business Green Frahg Productions. You have become the owner and operator of Green Frahg Productions. You want all bank accounts, receipts, bills, payments, everything financial to funnel through Green Frahg Productions.
There are many ways to do this.
To open a bank account in the United States under the name Green Frahg Productions, you’ll need a DBA document. That’s a Doing Business As form which you can get from your bank. You’ll need to file that form with the state. Once you’ve filled out that form with all the pertinent information, you can then open your accounts under the name Green Frahg Productions.
It’s really that simple. Each state has different regulations. Your banker will tell you what the regulations are for your state. I have a hunch it works this way in each country as well.
You’ll be on the DBA as the owner and operator, but Green Frahg becomes the public face of your business, not you. The check for any purchased material will come to Green Frahg Productions. The only problem comes in signing the contract. Someone has to sign as a representative of Green Frahg, and that someone is you.
A DBA is the simplest way to assume a name other than yours for your business. A corporation is an extremely complicated way, and if you want a corporate identity only for the name, then you don’t understand corporations.
Under U.S. law (and under the laws of many other countries), a corporation is a separate entity. In other words, it exists, like a person exists. In the U.S., we’re constantly arguing about what that means. The major Supreme Court case this year, Citizens United v. Federal Election Commission, that caused so much controversy is a case about (among other things) the definition of a corporation under the law. These things change all the time, and there are books upon books upon books defining what a corporation is, what its tax liability is, and what regulations it must follow.
Not to mention that inside the United States, corporations can take various forms. Some have limited liability. Some are public—meaning that anyone can buy stock in it (through the correct channels). Some are private. There is subchapter this and structure that, and they all follow different rules.
One thing each corporation holds in common is this: If you decide to incorporate, your paperwork will increase exponentially. You’ll have to have board meetings. You’ll need to document everything. Your finances must be handled a certain way. Your taxes must be handled a certain way.
If you fail to follow those rules, you are legally liable for all kinds of nastiness. Taking on a corporation is a mighty task, one you shouldn’t do lightly, if at all. It’s certainly not something you can decide on your own. You’ll need to hire an attorney to help you incorporate. Make sure that the attorney you hire is a business attorney who handles corporations routinely.
You’ll also need a certified public accountant to help you set up the books of your corporation. Those books must be set up to a particular standard, and that standard has to be maintained.
If you have stockholders, then you’ll need to do reports, filings, disclosures and all kinds of things like that. Corporations, in case you can’t tell, are a gigantic pain in the butt.
So…if corporations are a pain, why do people incorporate their businesses?
For a variety of reasons. Many will incorporate to minimize their personal tax liability. If your business starts making profits in the hundreds of thousands, then you might want to consider incorporating. Your tax liability (in the States) might go down. It might not. I know people who have so badly mishandled their corporations that their tax liability went up.
If your business is a risky one, then you might want a corporation to stand between you and any legal liabilities. If you’re afraid that you could get sued routinely for standard business practices, then you might want to incorporate.
It sounds like I’m talking about criminal businesses here, but I’m not. I’m talking about a business, like a gym, where injury might be common, and lawsuits are expected. People hurt themselves all the time on gym equipment, and it doesn’t matter how often you explain how to use the equipment correctly. People will sue.
If you own the gym as a sole proprietor, then any legal damages could come out of your own personal wealth. Your kid’s college savings might go instead to the dumb guy who decided he could bench-press an extra 50 lbs and broke bones doing so. Yeah, you warned him, but you didn’t take the weights away from him. And the jury found for the dumb guy. Your kid suddenly isn’t going to college.
Unless your gym is incorporated and—here’s the rub—it’s the right kind of corporation, then you might be protected. Some corporations aren’t protection against a lawsuit like that. Some are. The ones that are will act in this way: the court will take the damages from the corporation’s finances and leave yours alone.
Again, it depends on what you need the corporation for.
So if you are thinking of incorporating, either to protect yourself from huge tax bills or to protect yourself from standard (and expected) lawsuits that are the cost of doing business, do these things:
1. Research, research, research. Read up on corporations. Then find the right people to talk to. Research the attorneys you might hire. Research the accounting firms. Figure out what you really need before you ask for help.
2. Hire the correct attorney and listen to what she has to say. Ask the right questions. Tell her exactly what you want the corporation for. Ask her about taxes, liabilities, benefits and drawbacks to the various corporations she proposes. You might want to see a second and third attorney to get their opinions as well. You don’t want to have the wrong type of corporation when all is said and done.
3. Hire the right accountant and listen to what he has to say. He’s going to help you set up your finances. He’s going to set up your accounts, and he’s going to tell you how the accounts work for your type of corporation. Follow his instructions and setup to the letter. If you don’t do this, you could be subject to extra taxes, fines, and all kinds of ugliness.
4. Keep a wall between you and that corporation. Don’t blur your finances. Don’t blur your taxes. Don’t tell people you are the business when you are not. Think of the corporation as another person and don’t ever, ever steal that other person’s identity.
5. If you have shareholders, keep them informed. The law requires this, of course, but so many small corporations don’t do it. Do it. That prevents shareholder lawsuits.
If all of this talk of tax liability and rules and thick books and lawyers and accounting regulations and lawsuits scares you, good. It should. Because incorporating is a big decision and not one you should take lightly.
It’s a decision that most of you should not take at all. Be happy with your DBA or your unnamed sole proprietorship. Plug along at your small business, and keep it small.
Once you become a corporation, you’re playing with the big boys, and believe me, they play nasty. Stay out of their game if you can at all avoid it. If you decide to join them, then be prepared—and follow the rules.
You’ll be glad you did.
“Freelancer Writer’s Survival Guide: “Incorporation” copyright 2010 by Kristine Kathryn Rusch.