Should You Incorporate Your Business?

I have recently heard from many providers, "My accountant has advised me to form a corporation."

For the vast majority of family child care providers this is bad advice.

There are four basic types of business structures under which you can operate your business: sole proprietor (also known as self employed), partnership, a single person Limited Liability Company (LLC), and a corporation (S or C corporation).

Once your start your business you are automatically treated as a sole proprietor. There are no forms to fill out. If you are going to consider operating under one of the other three options you should know that this can be a very complicated decision with both tax and legal complications. Therefore, before making this decision I strongly recommend that you consult with both a tax professional and an attorney that understand family child care.

There are two basic reasons why child care providers consider otherbusiness structures: lower taxes and personal liability protection.

Taxes

There are no tax savings if you form a partnership or single person LLC. There may be some tax savings if you operate as a corporation, but probably only if you have a profit of at least $30,000 each year. Also, take these points into consideration: you will lose the ability to deduct your house depreciation if you form a partnership or S or C corporation, the cost to set up a corporation can be hundreds of dollars, there are annual fees for corporations and LLCs, and your tax preparer will probably charge you more to do corporate tax returns. Ask your tax preparer to show you exactly how much in taxes, if any, you would save by incorporating.

Personal liability

If you form an LLC or incorporate your business you may get some personal liability protection. This means that your personal assets may be protected if you are sued. However, you should not assume that such protection is automatic. If you are negligent and a child is injured or if you are accused of child abuse – being incorporated won’t protect you. In addition, there are many business formalities to follow as a corporation (separate business and personal records, stockholder meetings, following your bylaws, etc.) and if you fail to follow them all you could lose this protection.

The biggest problem of being a corporation (including an LLC) is the extra record keeping. You must keep separate business and personal records. Let's say you go to the store and buy some paper towels and laundry detergent. Since this is both a business and personal expense, if you write a check from your business account (or from your business credit card) you have commingled business and personal funds and you will lose any personal liability protection.

So, you must pay for items that are both business and personal out of your personal account. You can deduct the business portion of the paper towels and laundry detergent by applying your Time-Space Percentage. But, you won't know your Time-Space Percentage until the year is over. At that time you would write a check out of your personal account to your business account for each such receipt. What a pain in the neck!

Summary

Forming an LLC or a corporation is no substitute for having an adequate amount of business liability insurance ($1 million per occurrence and $2-3 million aggregate). With this insurance you can protect yourself from risks associated with your business. Check out my child care insurance directory.

Child care providers who have a large business profit each year (at least $30,000), have a significant amount of personal assets they wish to protect, don’t mind doing extra record keeping, and plan to be in business for a number of years may want to look into a business structure other than a sole proprietor. If this is you then you should seek out professional legal and tax assistance first.

But everyone else should keep operating as a sole proprietor.

I’ve written about the pros and cons these business structures at length in my book Family Child Care Legal & Insurance Guide.

Image credit: http://www.differencebetween.net/business/difference-between-franchise-and-corporation/