Sheltering personal assets and making personal expenses corporate expenses?
June 7, 2006 9:33 AM   Subscribe

How realistic is the idea that you can shelter your personal assets as well as many typical expenses under the umbrella of a corporation?

I've heard stated several times in different books that corporations (LLCs) can be used to shelter an individual's personal assets, investment or otherwise, reduce your personal taxes by holding much of your income in the corporation, and permit you to expense many things to the corporation (cars, restaurant bills, etc). This idea seems to hold a little water, as I know plenty of people with a network of corporations. While the authors of these books are not always well-regarded by the Internet community-at-large, i'm trying to find out the truth of whether or not this is possible and for whom it is suitable. If you have experience in doing this kind of thing, your input would be a big plus. (Disclaimer: I plan on seeking the advice of a lawyer before proceeding, just curious as to what the knowledge of askmefi brings).
posted by arimathea to Work & Money (14 answers total) 2 users marked this as a favorite
This is totally standard operating procedure in Los Angeles for anyone making 6 figures (or close to that), which is plenty of people in the entertainment industry, as well as many other self-employed individuals. While I am not sure of the exact tax implications that make this so, my understanding is that most companies with semi-consistent employess bases don't want to pay their employees through another company, so it doesn't neccesarily work if you're a doctor or a lawyer and not a partner in your firm. In the entertainment industry, however, most employers do not fall into this category, as far as I can tell. And if you are self-employed in any industry (i.e. getting paid through 1099's) and make enough money, it is absolutely a way to avoid self-employment tax - You only get hit on the money you pay yourself as salary, and the rest goes into the operating expenses.

Why exactly do you think this is not feasible? Do you know your friends' tax situations intimately enough to know they don't operate in exactly this fashion?
posted by mzurer at 10:06 AM on June 7, 2006

In some situations, corporate tax rates are actually higher than personal tax rates. Most of the folks I know who are in these situations and incorporated anyway did so to protect their personal assets from liability.

For instance, "Joe Doakes, MD, a medical corporation" (i.e., a LLC) can be sued for malpractice the same way that "Joe Doakes, MD" can. However, the damages that Joe Doakes MD LLC can be liable for are limited to the assets of the corporation. Plain old Joe Doakes MD (non-incorporated) could lose his house, his car, everything he owns.

Limited liability isn't the only reason to incorporate, but for a lot of legit one-person corporations out there it's a major part of it.
posted by ikkyu2 at 10:13 AM on June 7, 2006

There's also a little rule that says the LLC must not just be created for tax-sheltering purposes and you must be able to prove that these expenses somehow were in an attempt to further the business.

This would apply moreso on the small $$$ company side (i.e. buying a new car and expensing it as a business expence might look at little fishy to your $50,000 accounting business, but it might be less noticable in your $40m company).

posted by jimmy0x52 at 10:14 AM on June 7, 2006

If your primary income comes from a business, then running your business through a corporation or an LLC (note: two very different things!) can make sense for a number of reasons. But anyone who tells you that they can "shelter" you from taxes by having you assign all your income to a corporation is probably a fraudster.
posted by profwhat at 10:16 AM on June 7, 2006

There's a lot to unpack here.

First, one of the main reasons one forms a corporation is to protect one's personal assets from the liabilities associated with one's business. To achieve this, far from putting personal assets in to the corporation, one keeps them out of the corporation. Unfortunately, many small businesspeople are frustrated in their attempts to do this because knowledgable vendors and counterparties demand personal guarantees of corporate obligations, which re-exposes the assets one had thought to protect. (Entertainers who use loan-out corporations are always required to personally guarantee, by the way...)

Second, it is a complete myth that one can claim as business expenses the cost of truly personal needs run though one's closely held corporation. The IRS scrutinizes small businessmen carefully and you will eventually be caught. However, there is a real benefit of acting through a corporation insofar as individual filers are denied tax benefits for some or all of a number of legitimate business expenditures that he can effectively realize if he establishes a corporation, especially if the individual filer is subject to AMT.

In terms of payroll tax, it's a dangerous game to try to take money out of your corporation as dividends or distributions when you've taken out less salary than would take you up to the maximum social security. However, it can be very helpful in terms of Medicare tax, which has no maximum, especially if the business is very profitable.

For a typical very small businessman, it must be said that the total tax benefit of acting through a corporation is likely to offset (heavily, and sometimes entirely) by the legal and administrative costs of setting up and maintaining the corporation. Limited liability for one's personal assets is, by far, the compelling reason to incorporate a small business.
posted by MattD at 10:51 AM on June 7, 2006 [1 favorite]

Many people mistakenly think incorporation is an almost absolute protection against loss of personal assets, but as my then-accountant told me long ago when I asked whether I needed to incorporate, there's this little concept called "piercing the corporate veil" which makes it less than a tidy automatic decision.

In short, incorporation is not a blanket protection of one's assets, and it doesn't always make good business or financial sense. I've been a sole prop for over 20 years and never been incorporated, on the advice of two CPAs and one attorney (not simultaneously, just over the years). Incorporation is an additional record-keeping and income-filing hassle, and a yearly expense which is unnecessary for many.

That said, there are a lot of vanity corps created by people who like being the "CEO" of a corporation with one or two related shareholders. Oh well, at least it's cheaper than a Ferrari, and potentially far more useful.
posted by mdevore at 11:21 AM on June 7, 2006

MattD really nails it. Incorporation does not really make sense for tax purposes unless your business nets a profit that is much, much higher than your annual salary. In that case you can temporarily shelter some of your profits in the company at a lower tax rate. The much simpler sole proprietorship or partnership is eligible for the majority of business deductions without the hassle of a corporation.

As far as limited liability goes, most people don't need it. If you are a lawyer, accountant, doctor or architect, you may be subject to expensive malpractice claims. But the majority of 1099 subcontractors, such as software engineers, writers or laborers have nothing more at risk than their next paycheck. A sole proprietorship will be less costly.
posted by JackFlash at 11:31 AM on June 7, 2006

I have to agree with what JackFlash said... I've made five to six figures for almost 10 years, doing the examples he cites, and have never even had a threat of a lawsuit. I keep all customers very happy and don't skimp on refunds. It's a calculated risk of course, and depends on your occupation, but I have decided to stay on the sole proprietorship boat.
posted by zek at 12:09 PM on June 7, 2006

There are also other ways to address business liabilities, such as by taking out appropriate insurance. Being unincorporated doesn't have to mean that everything you own is left at risk.

It may also give you some comfort to realize that if you ever got hit with a truly huge liability claim, although you would take a hurtin' it's not that likely that you'd lose everything. Because bankruptcy laws (which -- last time I checked, which was pre-"reform"-- vary wildly between states) provide exemptions for various types of personal property including "homestead", pension, etc. This is partly why O.J. Simpson gets to spend the rest of his life on the golf course and the Goldman family will never be able to collection more than a fraction of the judgement amount.

So if you live a really opulent lifestyle, you might have to sell off the extra sports cars and downgrade to a a non-mansion type house. But it's not like you'd be destitute.

posted by nakedcodemonkey at 12:57 PM on June 7, 2006

For a typical very small businessman, it must be said that the total tax benefit of acting through a corporation is likely to offset (heavily, and sometimes entirely) by the legal and administrative costs of setting up and maintaining the corporation.

This cannot be overstated. I have a corporation set up for my side business (else I would take a horrible pounding taxwise since I'd be unable to deduct all the raw materials and tools used to make the product) but the emotional headache and time involved in upkeep is significant. If you dread April 15th you'll dread March 15th even more, not to mention your state and locality filings.
posted by phearlez at 2:00 PM on June 7, 2006

As far as limited liability goes, most people don't need it. If you are a lawyer, accountant, doctor or architect, you may be subject to expensive malpractice claims.

Actually, my understanding is that limited liability cannot be used to escape liability for professional malpractice claims.
posted by reverendX at 2:52 PM on June 7, 2006

Actually, my understanding is that limited liability cannot be used to escape liability for professional malpractice claims.

Correct. You don't escape liability. You just cap it to the assets of the medical corporation, which are usually considerable and include a malpractice insurance policy.

So if some jury decides to award $25 million punitive damages because you were the obstetrician who happened to be present when your irreversibly brain-damaged kid was born, your malpractice insurance would pay its cap, your LLC would hold a fire sale and transfer all proceeds to the plantiff, and you'd go out of business; but you wouldn't lose your house.
posted by ikkyu2 at 3:12 PM on June 7, 2006

ikkyu2: Actually the law in most states is that for professional activities, the personal assets of the professional are reachable in a malpractice action regardless of the use of a limited liability entity. (after any insurance is extinguished). Limited liability would still be a benefit for any liability not based on malpractice. (i.e. someone trips on your office sidewalk)
posted by reverendX at 6:21 PM on June 7, 2006

That's horrible, reverendX. Do you know of anywhere I could read more about this topic?
posted by ikkyu2 at 10:48 PM on June 13, 2006

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