Unincorporated Businesses: All of the Risk, none of the Reward

The following is an excerpt from the book Smart Business, Stupid Business, written by Diane Kennedy of US TaxAid and Megan Hughes of Smart Business Incorporation.

Informal businesses are bad from a tax angle. You lose all kinds of tax reduction opportunities, including the ability to stream income. That alone can cause you to pay thousands of extra dollars in tax.

But it can get worse. You could go into an informal business with one or more partners. How you have all of the negatives, multiplied by the number of other people you’re in business with. This type of informal business is called a general partnership, and it’s probably the worst choice of all. It only takes one partner to bind a business. So your partner(s) can put you on the hook and risk your personal assets without you knowing anything about it it. Until, the lawsuits start flying.

If you really want to have an uincorporated, informal business, then there are only two times we would recommend it;

1. If there is very little risk from the business, or
2. You don’t have anything to lose

Formal Business Structures

Let’s be clear here, though. We want you to have a formal business structure for your business. The number one reason is liability protection. We call this wall of corporate veil. If you obey all of the rules and regulations set out by state law and the IRS, you are, by law, protected. Those acts and debts stay with the business. If your business can’t pay its debts, you are sfae from its creditors (unless you have personally guaranteed the debt). If your business is sued by a client or third party, you can’t be sued personally as the operator of the business, at least in most cases. Where you’ve done something criminally wrong, different rules apply. There are also different rules for professionals like doctors, lawyers, engineers, accountants, and the like. If a client makes a complaint against you to your professional association, you could be found personally liable, depending on the circumstances of the complaint, and it could affect your malpractice insurance coverage.

However, when you don’t follow the rules and regulations, you can easily lose the protection of the corporate veil. Some of the things that can trip you up are:

1. Your records are incomplete,
2. You mix up business funds with personal funds,
3. You underfund the business (in other words, you don’t invest a reasonable amount into the business at the beginning, or keep enough money on hand for your business to operate independently)
4. You don’t file annual reports or keep proper corporate records,
5. You allow your business structure to be dissolved by the state for failing to keep up with state filing requirements

Do one of these things, and you may as well be operating as an informal business, because that’s how you’re going to be treated by the legal system. We call situation “piercing the corporate veil”

If you enjoyed today’s blog, why not pick up your copy of Smart Business, Stupid Business today. Buy through our website, and you’ll also get a free instant audio download of the entire book!