Q&A: LLC or INC?
In my experience, until a business “gets off the ground”, and if there’s no concern of potential law suits or other requirements, it is usually preferable to operate under your own name.
Q: Dear CHYE I developed a product that I’ve been working on for the past year and showed it to a few people. I am encouraged with their response. A few even purchased it. I am very excited about moving forward. Until now I was working from my home (a basement) and to move forward I formed a corporation via an online web service and I am looking to rent space for an office, showroom and space to build the product. Can you advise me how to proceed?
A: Dear Mr New Product
Congratulation on the entrepreneurial spirit that is imparted in your letter.
I am curious why you chose to incorporate. Did the web service you used offer any consultation or advice about other options? Specifically, did they explain the benefits and disadvantages of incorporating versus another choice of entity.
Now that you formed a corporation you are subject to various filing requirements such as NY State and NYC Franchise and Corporate taxes. Even if you are inactive or have a loss you are subject to minimum tax liabilities. If your business is profitable and you plan to withdraw money, you will be treated as an employee. There’s a distinction between a shareholder and an employee. You may own 100% of the corporation but money that you withdraw is treated as wages and subject to payroll taxes, including Social Security, Medicare and unemployment. There are also strict regulations as to when and how to submit those taxes. Penalties and interest will be assessed for noncompliance. All that could have been avoided with a different choice of entity.
In my experience, until a business “gets off the ground”, and if there’s no concern of potential law suits or other requirements, it is usually preferable to operate under your own name. It offers most flexibility as well as least Governmental filing requirements. You can always incorporate later. But for many reasons, today’s preferred choice of entity is a Limited Liability Company (LLC), either single member or as a partnership.
Before committing yourself to rent and other expenses consider carefully the cash flow the business will generate. Try to project a realistic scenario of the business income and expenses. Start with estimating your gross margin. For example, if your product sells for $20 but costs you $12 to produce, your gross margin is $8 per unit. If your rent is $2,000 per month, you’ll need to sell 250 units just to cover the rent. Overhead expenses such as utilities, insurance, supplies, marketing and other expenses can easily double the number of units you must sell just to break even.
I recall how a few years ago as I was driving to work daily, I saw a vendor selling flowers at a certain street corner. She was at that location for a couple of years doing brisk business. Apparently she felt confident enough in her business that she moved her business to a store she rented near my office. Unfortunately six months later she was back selling flowers at the street corner. I approached her and asked what happened. She told me that while her business actually increased from the street corner, she greatly underestimated her expenses. Although at times she had to endure the outdoors inclement weather, she was now profitable again because she had no overhead.
Bottom line: if you plan to be in business, get educated in all aspects of the trade before you act.
Good luck
Asher Lieblich is a CPA and principal of Lieblich Financial Services. He is also a Business Mentor at CHYE