There’s been a lot of crazy talk lately among non-lawyer, non-CPA bloggers accusing lawyers and CPAs of advising their clients to incorporate merely to get additional fees.
These bloggers offer no evidence to support their claims and merely assume that because lawyers and CPAs sometimes incorporate their clients for a fee that they are advising them to incorporate for that reason alone.
This is a silly charge, of course, but it doesn’t stop these folks from spewing it.
Let’s put this sucker to rest once and for all, shall we?
There are 5 indisputable advantages of the corporate or LLC form of business
1. Credibility- Many vendors, customers and suppliers prefer to do business with entities that are incorporated or operating as LLCs. There is a good reason for this. Most legitimate and serious business entities operate as corporations or limited liability companies and there is a credibility gap in the marketplace between sole-proprietorships and corporations/LLCs.
2. Asset Protection - This is by far the most important reason why the small business owner should incorporate or form an LLC. Corporations and Limited Liability Companies are separate legal entities and, as such, the creditors of these companies can generally proceed only against the assets owned by them. In other words, the personal assets of the shareholders are insulated from liability for corporate debts.
3. Tax advantages- IRS statistics show that it audits Schedule C businesses much more frequently than it does S Corporations and LLCs. This reason alone is sufficient to justify the additional costs and paperwork associated with forming a separate legal entity and filing its annual report and tax return. Also, operation as an S Corporation allows owners to distribute at least some of their business profits as non-self employment income thereby avoiding the 15.3% self-employment tax to which all of the net income of a sole proprietor is subject.
4. Insurance advantages- Because liability is limited only to corporate assets, insurance companies are able to insure incorporated businesses and LLCs at lower premium rates due to the lowered risk.
5. Independent contractor status - Independent contractors who operate in the corporate or LLC form of business have a better chance of having their independent contractor status upheld by the IRS. Many independent contractors incorporate and then have their businesses enter into written contracts with their customers. The corporation then pays the independent contractor some combination of wages subject to self-employment tax and distributions exempt from self-employment tax.
There is 1 dubious advantage of the sole proprietorship form of business
1. Short-term cost savings – The only advantage of operating a business as a sole proprietorship rather than a corporation or LLC is short-term cost savings. And even this advantage is fleeting because failing to insulate yourself from personal liability by operating in the corporate or LLC form could in the long run end up costing the small business owner thousands , if not millions, of dollars and a destroyed credit rating. Failing to incorporate or operate as an LLC in order to save a few bucks is penny wise and pound foolish and many small business owners have been forced into personal bankruptcy because they did so.
Good lawyers/CPAs and unenrolled preparers regularly give their clients advice in exchange for fees
Here are some other things I advise my clients to do for which I obtain fees:
1. Prepare a Will - Probably everyone in the work force should have a will, but definitely everyone with children should have one. We charge about $500 for a simple will, living will and durable power of attorney.
2. Reduce Agreements to Writing- The days of the handshake deal are long gone. I advise my clients to get their agreements in writing so that there can be no confusion about the obligations of the parties. We get paid for drafting business sale contracts, employee and independent contractor agreements and covenants not to compete.
3. Hire a Tax Preparer – If a taxpayer just has a w-2 and no other complicating transactions, I have no problem with them preparing their own tax returns. But if they itemize, have stock or asset sales or other items, I advise them to hire a qualified tax preparer to help them with tax planning and the preparation of their tax returns. Our tax preparation department charges anywhere from $150 for a simple return to several thousands of dollars for a complex return.
Incorporation/LLC fees do not convert good advice into bad advice
I make my living giving people legal, accounting and tax advice.
When a person hires me to provide a professional service for them, the exchange can be summarized as follows: The client pays me a fee in exchange for my performance of a service.
Consequently, in much the same way an unenrolled preparer benefits when a taxpayer hires him or her to prepare their tax return, I benefit every time a client hires me to provide a service.
I doubt that anyone would suggest that the unenrolled tax preparer advises taxpayers to have a tax pro prepare their returns simply because he wants the fee?
There is a good reason for this: It is good advice to tell someone to have a tax professional prepare their tax return for them.
It is also good advice to tell small business owners not to operate their businesses as sole-proprietorships.
If it’s good advice, the fact that the attorney/CPA gets a fee for it is irrelevant
In order for the accusation to stick that lawyers and CPAs advise their clients to incorporate because of greed, it must be proven that it is bad advice and not merely that the attorney or CPA gets a fee for it.
If this is all that were required to be shown, then we should also assign greedy motives to the surgeon who advises his patient to undergo surgery and the stockbroker who advises his client to have a diversified portfolio.
I have yet to hear a single compelling reason on why it is bad advice to tell small business owners to incorporate their businesses or form LLCs.
It is wise to incorporate even if you do it yourself, which many of our clients do
Florida, the state in which I practice, has an online incorporation website that allows most individuals to easily incorporate their own businesses.
For this reason many if not most of our clients now choose to incorporate or form an LLC themselves. We or an outside CPA are hired merely to make the appropriate tax filings and elections.
We are sometimes hired to do the corporation or LLC tax return; however, the preparation of those returns does not create a significant amount of additional work compared to the preparation of Schedules C (returns of sole proprietorships).
Regardless of whether we are hired to form the corporation or LLC, we advise our small business clients not to operate as sole-proprietorships.
15 responses so far ↓
1 Monica Lawver // Aug 19, 2009 at 10:52 pm
I definitely agree with your statement that: “If it’s good advice, the fact that the attorney/CPA gets a fee for it is irrelevant.”
In her now infamous post on a separate banking account, June Walker wrote: “Most accountants disagree strongly with my position – because they don’t know you like I know you. My system will save you money and time; their advice will cost you money and time.”
My advice costs money because it provides value. I wouldn’t last too long charging clients for bad advice, and have no intention of doing so.
I intend to earn a good living throughout my career, and believe focusing on value is the best way to do that — not by just trying to find ways to generate fees. Like you, I intend to give good advice, whether the result of that advice will get me extra money or not.
2 Peter // Aug 20, 2009 at 8:47 am
Monica,
Hi there and thanks for the comment.
The truth is I would make more money in audit representations, appeals work and tax court cases if all of my small business clients were schedule C’s rather than corporations or LLCs.
I agree 100%, though, that the cost of giving bad advice to get a short-term spike in fees is much greater than giving good advice and gaining a long-term reputation for doing so.
Some folks are awfully cynical.
3 David Shulman // Aug 20, 2009 at 8:14 pm
If a client comes to me tells me that they own investment real estate in their own name, or is running almost any type of business as a sole proprietorship, I think its malpractice if I don’t advise them about the benefits of entities.
4 Peter // Aug 20, 2009 at 8:45 pm
David,
I agree, although I’d think twice before putting real estate in a corporation.
5 David Shulman // Aug 20, 2009 at 8:50 pm
Peter, I agree too. I said “entities” but real estate goes into the LLC. I don’t even like the S-Corp that much anymore, mainly b/c I’ve seen too many blown elections.
6 Jeff Day // Aug 20, 2009 at 10:53 pm
So, I have a client that owns a business operating a transmission repair business. And the above would lead someone to believe that his customers think he would be more credible if he is a S-Corp or a C-Corp instead of a sole proprietor? Yea Right!
When it is mentioned that statistics show sole propietorships are more likely to be audited than various corps? I have never seen any such statistic and would love to see a link. I do my best to prepare tax returns that are the most advantageous within the law, not ones that are less likely to be audited. I have been reading of late that the IRS is now focusing on S-Corps where it appears the business is setting up a S-Corp to deliberately understate the FICA taxes on the owner(s).
Going back to the transmission shop. I prepared the tax returns relative through the year 2006. My fees for the personal tax return (owners husband and wife) with the business included was aproximately $600.00. The wife was the actual owner with the husband an employee of wife. Local CPA firm got her to set up a s-corp effective 01-01-07. They prepared a tax return and the cost of the s-corp alone was $1300, have no idea the cost of the personal return for 2007 return.
Effective 01-01-08 there was a second s-corp set up by/with advice of the CPA. Cost of the two S-corps was $2300 for 2008 returns. The 2008 return showed the wife a salary of $35000 (social security taxes aproximately $5200) The two S-corps showed a bottom line loss of $17000 between the two returns netted. Had they still been a sole propetierorship, the social security taxes would have been aproximately $2700.
So this husband and wife with a local independent transmission shop paid the CPA firm almost 4 times my price. So this husband and wife with a local independent transmission shop paid in FICA taxes aproximately $2500 more than had everything been left alone. (and no I don’t think that is necessarily bad).
I am back doing the tax returns.
Now if the business has to buy/lease new equipment the above author would lead folks to believe their liability would be protected since it was purchased only by the business, but guess what their suppliers routinely demand personal guarantees, which makes that “protection” valueless. Their landlord has personal signatures on the lease agreement.
Since the owners are the ones that overwhelmingly do the majority of the work, and someone complains shody work, someone doesn’t think that the person “injured” isn’t going to sue the store as well as the owners since the owners did the work? You really don’t think so?
I happen to personally know the senior stakeholder liaison officer of the IRS for the State of Indiana. by copying this link to him I will be requesting if it is possible to get such statistics.
Would be interesting to know if the IRS feels tax returns should be prepared with the goal in mind of minimizing the risk of audit instead of a goal what is the most legally advantageous and/or accurate tax returns.
I work for a large company and personally represent most clients of the company that are audited in the Evansville area. I wouldn’t charge anything to represent in an audit, if I personally prepared the tax return. The company sets up a flat charge per hour for company prepared returns and is irrelevant to the entity involved.
But I can tell you that I personally prepared (with two assistants) over 800 tax returns last year have been in the business more than just a few years and as of now, I have never been involved in an audit that the final determination was any worse (for taxpayers) than what I initially thought should be.
Jeff Day
7 Peter // Aug 21, 2009 at 8:17 am
Jeff,
There are 5 reasons, remember?
If a customer of your transmission repairman’s business slips on an oil spill, busts his head and ends up brain damaged guess who is forced into bankruptcy if there is no corporation?
Limiting liability is the number 1 reason for incorporation and all by its lonesome surpasses in importance any reason I have ever heard for operating as a sole proprietorship.
I fear you miss the main point of my post:
There are some awfully good reasons for recommending the corporate or LLC form of business besides the fact that I get more fees!
8 Jeff Day // Aug 21, 2009 at 9:10 am
The real only “complaint” that I could make of you, with so little knowledge of you: you take things much too personal.
I never once claimed that you were/are/would be unethical in your handling of affairs. I claimed that there are too many CPA/lawyer’s that DO encourage setting up the entities and are much too motivated by the fees. I think there also too many insurance agents with wrong motivations. Too many sold “whole life” insurance policies when should have been a “term” policy. That doesn’t mean every insurance agent that ever sold a whole life policy was wrong.
I think there are wayyyy too many tax preparers that prepare tax returns in ways that are over-priced, and I am not referring to the CPA’s but unenrolled preparers. There are even some in the company that I work for. And no I don’t get along with them either.
I know you not, therefore I can not and would not make any accusations of you personally.
Regarding the above “oil spill”, again very coincidental that just a couple weeks ago I mentioned to that client, he might want to consider talking to his insurance agent about procuring a million dollar umbrella policy, which is very inexpensive, just for those type of reasons.
But cutting it to the chase, each person/each business should always strive to treat each customer/taxpayer the way it would want to be treated. Each taxpayer’s case is an individual case and should be considered individually. It is wrong to say that every small business should set up as a corporation. It is wrong to say that no small business should set up as a corporation.
Thank you for having allowed me to vent off at you.
Jeff Day EA
Evansville, IN
9 Peter // Aug 21, 2009 at 10:24 am
Jeff,
Because I refuse to let unsupportable slanders marinate in the minds of readers doesn’t mean I am hypersensitive.
By the way, charging that lawyers and CPAs generally give bad advice just to make more money for themselves is personal since I am both a lawyer and a CPA.
But I forgive you because I like you.
; )
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13 Bella Smith // Sep 20, 2010 at 6:32 am
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Bella Smith
14 Bella Smith // Oct 18, 2010 at 1:43 pm
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