Incorporation glossary * Sole proprietorships: A one-person business that is not registered with the state as a limited liability company (LLC) or corporation. There are no papers to file to set up a sole proprietorship ------ you create one just by going into business for yourself. Legally, a sole proprietorship is inseparable from its owner --- the business and the owner are one and the same. The business owner reports income and losses on her or his personal tax return and is personally liable for business-related obligations such as debts or court judgments. * Corporation: An independent legal and tax entity, separate from the people who own, control and manage it. In a regular corporation (also known as a C corporation), the company itself is taxed on business profits. The owners pay individual income tax only on money that they draw from the corporation as salary, bonuses or dividends. By contrast, in an S corporation, all business profits pass through to the owners, who report them on their personal tax returns (as in sole proprietorships, partnerships and LLCs). The S corporation itself does not pay any income tax, but it must report each shareholder's portion of the corporate income to the IRS. * Limited liability company: Similar to corporations because they provide limited personal liability for business debts and claims. But when it comes to taxes, the owners of an LLC pay taxes on their shares of the business income on their personal tax returns. Source: Nolo.com Tax seminar * What: A two-hour seminar, "Tax Aspects of Starting and Running a Business," conducted by certified public accountant Michael Flowers. * When: 8 to 10 a.m. July 19 at the Arizona Small Business Association, 4444 E. Grant Road, Suite 119. * Cost: The seminar is free to members of the Arizona Small Business Association; $5 for nonmembers. * Call 327-0222 to make reservations. * Information: For more on incorporating, contact an attorney or certified public accountant, or call the Arizona Department of Commerce at 1-800-542-5684 to order "The Small Business Book 2001," which includes details regarding corporations, limited liability companies and more. Incorporating a business can protect the company's principals from personal legal liability and sometimes save them thousands of dollars in taxes. So why doesn't every business do it? Businesses are often scared off by myths, said Michael Flowers, a certified public accountant. Among the perceptions: A business has to have a certain amount of income to incorporate (false); a company has to have a minimum number of employees (false); and incorporating requires extra paperwork (true). "Sometimes people think: 'That's for the big guys. That's what the big companies do,' " said attorney Deborah Gronet. Theresa Garza disagrees. Her business, Amigo Meeting Solutions, has just one full-time employee - Garza - and one part-time worker. Garza's business has been in existence 4 1/2 years, but last year was the first year she made a profit. Her accountant recommended she incorporate so she could save money at tax time and protect herself from legal liability. Garza was tight on funds and did not want to pay an attorney to go through the process of incorporating. So she spent about 10 hours researching incorporation through the University of Arizona Law Library, the Tucson-Pima Public Library and the Internet, then spent $240 to file all the paperwork. She also got advice from some friends in the legal profession. "I did a lot of research and I ended up doing it on my own, but I don't recommend it," Garza said. Tax savings Corporations are all Subchapter C corporations unless they or their accountant select the Subchapter S tax election, Gronet said. In a regular Subchapter C corporation, the business is taxed on profits, and business owners pay tax on their salaries, dividends and bonuses. In a Subchapter S corporation, the profits pass through to the owners, who report the profits on their individual income-tax returns. The corporation itself pays no income tax. "We've had examples where in the first year alone they can save $5,000 to $10,000 alone in personal income tax," Flowers said. A business must meet certain qualifications to choose the S election. The business can have no more than 75 shareholders; it can't have nonindividuals as shareholders; and, generally, all the shareholders must be U.S. citizens. It's not just tax savings Garza was looking for. She also sought the legal safeguard a corporation provides: If someone sues a corporation, generally he or she can only go after the business assets. If someone sues a sole proprietor, he or she can go after the business and personal assets. "I've worked very hard for the little I have," she said. "As sole proprietor, you have no protection." How it works A corporation is an entity created according to statute, Gronet said. It is owned by stockholders (also called shareholders) and managed by a board of directors and a group of officers. It also issues stock to its stockholders. It can sound complicated, but it's not, particularly if a business works with an attorney or CPA, Flowers said. "What I tell my clients is you just need to have a leap of faith in trusting the professionals," he said. Once the corporation is in place, the business owner must take steps to maintain it. There is a $45 annual filing fee. The law also requires that shareholders and the board of directors hold annual meetings. These steps are important because if they are not followed, a court of law might decide the corporation is a sham, Gronet said, leaving the shareholders open to possible legal liability. To stay in line with these rules, companies generally pay attorneys to draw up meeting minutes. Even the initial cost is a small price for the return, Flowers said. "Actually, it's an investment because if they pay $1,500 and save $5,000, they're crazy not to take advantage of it," he said. Which way to go Instead of incorporating, many businesses opt to form limited- liability companies. Richard Bratt, a shareholder and consultant at the CPA firm of Beach Fleischman & Co., said LLCs are easy to form and allow for more flexibility than corporations in how earnings are distributed to the company. And, for the most part, they have the same legal liability aspects as a corporation. So how does a business owner know which is best for him or her - incorporation, limited-liability company or sole proprietorship, a company in which the owner has taken no legal steps to define its operations? "There are pages and pages of tax law on the subject," Bratt said. The best way sort it all out, he said, is to see an attorney or certified public accountant. "That's why we like to sit down and discuss the form of a company and what will work for each individual situation," he said. * Contact Star Business reporter Tiffany Kjos at 434-4083 or tkjos@azstarnet.com. Publication date: 2001-05-28 © 2001, YellowBrix, Inc.