Tire Dealer Inc.: Which is the Best Way to Form Your Business? - Tire Review Magazine

Tire Dealer Inc.: Which is the Best Way to Form Your Business?

There are six ways to form your business. Which is the right one for you?

Thought about incorporating your tire business, have you? The monetary cost to do so isn’t great ®ƒ say $500 or less, according to the many professionals who would help you with this step. But it’s a major step and you could stumble unless you consult the two "A"s – your Attorney and your Accountant.

Whatever form your business takes isn’t cast in concrete, and you can change the business structure of your dealership as the business develops. Most dealers start out as sole proprietors or in some form of partnership before changing to one of several corporation types down the road.

But why would a tire dealer want to incorporate?

There are many advantages to incorporation, based on the structure type you choose and the laws of the state you operate in, including protection from financial liability, long-term continuance of the business, the ability to raise capital, and certain tax deferrals or other income tax advantages.

Plus, having "Inc.," "LLC," "Corp." or "Ltd." next to your dealership’s name may help increase business, as consumers view "corporations" as being more stable and responsible. In some commercial tire markets, being incorporated may, in fact, be a requirement to obtain business.

The downside must also be considered. There is an increase in paperwork and costs, especially with corporate and personal income taxes. There are corporate meeting minutes that have to be maintained, corporate bylaws to write, and director, share and transfer registers. And there are reams of paper attached to taking your company public.

Because every dollar a corporation earns is taxed, you may lose some tax advantages. Also, corporations don’t enjoy the same flexibility as sole proprietorships. And, if the company’s credit is questionable, banks may insist that corporation officers put up personal guarantees to secure financing.

Before making any decision regarding incorporating, you should consider all the major forms of business structure

The two most popular forms of business structure – sole proprietorships and partnerships ®“ account for 70% of the 22 million business entities operating in the U.S. today.

The remaining 30% operate as one of four other types – limited partnership, limited liability company (LLC), C corporation, and Subchapter S corporation ®“ that offer different benefits depending on your circumstances.

The following is a discussion of all the major business formats and how you can best choose one. Included are cost details and tips on how to proceed regardless of whether or not you choose a professional to do the heavy lifting. Finally, there’s a list of sources for more details.

Sole Proprietorship

Want the most freedom in operating your business? Without a doubt, this is what a sole proprietorship offers. Here, the owner maintains complete control of the business, free of stockholders and of most government regulations, etc. Your way is the only way.

But there’s one major downside for the proprietorship in terms of financial liability. The sole owner is solely liable for all the business debts. Personal assets – houses, cars, boats, etc. ®“ are subject to any liabilities incurred by your company. Some states allow the shielding of personal assets from business risks by owning them jointly with a spouse or by transferring them to a spouse or children.

General Partnership

Then there’s the general partnership, as distinguished from the limited partnership. In the general variety, each partner has authority to enter into contracts and make other business decisions, unless the partnership agreement stipulates otherwise.

But just as with the sole partnership option, each partner is personally liable for all business debts. And each partner must report partnership income on individual tax return. Finally, unless otherwise stipulated, the partnership dissolves upon the death or withdrawal of a partner.

Family Partnership

Then there’s the family partnership (FP), which can reduce estate taxes and protect assets from creditors’ claims. FPs are either limited partnerships – with Georgia the most favorable state ®“ or limited liability companies (LLC), with Virginia being the most favorable.

With a FP, parents can transfer assets such as real estate or a share of the family business without any adverse tax consequences.

Parents retain exclusive control over the partnership and are entitled to compensation for their services. And parents also can give shares of the business to their children over time at discounts of 20% to 40%.

Limited Partnership

A limited partnership basically combines elements of general and limited partnerships, with the former controlling the business. General partners also are totally responsible for partnership liabilities; limited partners are liable only to the extent of their investment.

This partnership pays annual taxes with both limited and general partners reporting their share of partnership income or loss on their individual returns.

Death of a limited partner does not dissolve the business, but death of a general partner might, unless the agreement makes other provisions.

Limited Liability Corporation

In a LLC, the partners are not personally liable for business debts. They must report income and taxes on their individual returns. Many more regulations are involved here, with different states having different laws regarding the continuity of LLCs. In some states, a LLC dissolves on death or withdrawal of any owner.

Standard Corporation

Shareholders in a standard corporation are not personally responsible for its debts since the corporation operates as a stand-alone entity. Another major plus is that a corporation survives the death of an owner, partner or shareholder.

The biggest downside of operating as a standard corporation is the business suffers double taxation. First, the corporation profits are taxed and then taxed again when those profits are reported on the individual returns of shareholders. Avoiding such double taxation is the main reason many entrepreneurs opt for a Subchapter S corporation.

Subchapter S Corporation

Subchapter S corporations operate a lot like a regular corporation. However, shareholders usually (depending on regulations of the state where it is formed) avoid the double taxation burden. The profits and/or assets of this corporation type are not taxed, but shareholders are taxed on their share of profits received.

Generally, Subchapter S corporations enjoy all the benefits and avoid almost all the penalties of a regular corporation.

However, there are still downsides here. Subchapter S companies encounter more regulations, and these vary widely from state to state. Also, an IRS audit is more likely for this form of business than any other.

If you are the typical entrepreneur, you should find a way to retain majority control even in a partnership or corporation. Sharing ownership with others makes sense only when they bring sorely needed capital to the business or add complementary management skills. Otherwise, look at incorporation options that put control in your hands without putting too much risk on the table.

Simple Start for Proprietorship

Usually a business starts out as a sole proprietorship with only you and/or your spouse as owner. Simply open your door and you’re in business. No muss, no fuss. And termination is just as easy; simply close the door and walk away if you have no outstanding creditors. There are none of the legal ramifications of closure as with a corporation.

Yet, "one is the loneliest number," as the song says. In a sole proprietorship you may have no one in the business to share the troubles with. Therefore, you might consider a partnership, but first you need to answer "Yes" to the following questions:

1) Do you know that you need a partner? For cash? For knowledge?

2) Are you capable of working with partners or shareholders, sharing the decisions and profits as well as the risks?

3) Does your business fit the multiple ownership profile with room for two or more partners and the growth potential to support more than one?

4) Can you live with the legal requirements of multiple ownership?

Always scrutinize a partner prospect before signing on. Like marriages, more than half of all business partnerships break up after one to three years due to disputes. Realize that you will probably spend more time with that partner than you will your spouse, so compatibility is paramount.

Written Agreement Needed

A written formal partnership agreement is recommended, although it is not legally required. This will ease the problem of one partner wanting out of the business or the need for infusion of new capital in unequal contributions. The agreement should include:

®′ Duration of the partnership. This may specify that the agreement lapses when a business reaches a certain size or when profits are available to repay one partner’s initial investment. Otherwise, the duration is "in perpetuity."

®′ The time and money each partner will contribute. This portion must cover problems when the proportion of contributions change, such as one partner working longer hours than the other(s).

®′ The methods of making business decisions. Someone has to have the final word, unlike the sole proprietorship where your way is the only way, or in the corporation where the board of shareholders decides. You’ll get nowhere if every decision results in a one-one tie, so determine who gets the final say.

®′ Sharing of profit and losses. Usually these are in concert with the percentage of ownership involved. If not, then spell out in writing how profits will be shared.

®′ When to distribute profits. One partner may want to take profits out but another may wish to leave the money in to help business grow.

®′ Dissolution or restructuring in the event of the death of a partner.

Agree in Advance on Breakup

Breaking up is always hard to do so your partnership or corporate agreement should plan ahead for an eventual break-up. Many such advance plans deal just with a dissolution caused by death or permanent disability, ignoring the fact that most businesses dissolve over disagreements or personality conflicts.

Your advance "divorce agreement" should provide for payment of debts and the collection and distribution of receivables. Not to be overlooked is distribution of assets including office equipment and even the office phone number. Also, decide on whom gets which customers and staff members in the event you and your partner(s) wish to continue in business separately.

Provisions for the dissolution of a business should be made while you and the other principals are friendly. Waiting until a divorce is imminent jeopardizes coming to a fair agreement on terms.

Growth May Prompt Incorporation

As your business grows, you may be appalled at being personally liable for its growing debts, whether a sole proprietorship or a partnership. You might consider forming a corporation – the usual C corporation, a Subchapter S corporation or the LLC.

Most big businesses select C corporation status. Their large size usually prohibits either Subchapter S or LLC status.

It’s somewhat awkward to incorporate. This process can take from a few days to several weeks, or even require up to two months in some states where filings must be reviewed by the secretary of state and county officials.

Required government incorporation fees (federal and state) may range up to $1,000 depending on the state where you incorporate. Delaware charges just $70, which is why that state is the choice incorporation destination.

Subchapter S for Small Guy

To avoid the double taxation of the C corporation, there’s the Subchapter S, which has been called the "corporation of the small guy." This one is reserved for businesses with no more than 75 shareholders. The biggest benefit is it avoids the double taxation status of the C corporation and is subject to only personal income tax.

Start-up businesses wanting to avoid double taxation also choose the S class to have early-stage losses offset by one’s personal income. As their businesses grow, some owners opt to change from S to C class and leave a majority of the business earnings in the company and pay only the corporate tax rate on those earnings.

LLC is a Hybrid

Then there’s the new kid on the corporate block. Awarded official status by the IRS in 1988, the limited liability corporation is a hybrid combining the benefits of a corporation with those of a partnership.

Like a corporation, investors in a LLC bear no personal liability for debts or obligations of the firm. Like a partnership, the LLC affords favorable tax treatment with income flowing through untaxed until appearing on each investor’s personal income tax return.

A LLC has extraordinary flexibility and is ideal for an entrepreneurial or family business. Formal board approval for transactions is not necessary as it is in a corporation. There are no stock structure or shareholder limitations as in S corporations. Distinctions can be made between equity interest of employees, investor-non-managers or investor-managers based on future success of the business.

Unlike an S corporation, the LLC can be structured to allocate profits differently among the various members.

In an advantage over a partnership, a LLC can provide members with limited liability. Relationship of members in an LLC is controlled by an operating agreement, similar to a partnership agreement.

What’s the Cost?

So, if you decide to incorporate, what will it cost you? Total costs range from $270 to $880, according to The Company Corporation. David Clarke, affiliate manager, explains that this cost includes its charges of $199 to $380, plus state fees. Those state fees run to as much as $500 in Massachusetts.

This particular provider completes the incorporation and delivers the documents in an average of five to seven days. However, varying with the state of registration, the time can range from 24 hours to six weeks.

"We are the nation’s largest entrepreneurial incorporation service company," Clarke says. "We form over 25,000 new companies each year." Certainly it is the largest advertiser with frequently scheduled full-page testimonial ads in numerous publications. You can contact them at [email protected].

Then there’s the Corporation Makers (www.corpmakers.com) which lists costs for Nevada incorporation at $449. That includes $195 state fees, an $85 resident agent fee, $89 for prep and filing, plus $80 for a deluxe corporate kit, complete with leatherette binder (name in gold on the cover) containing your corporate charter, articles of incorporation, bylaws, first meeting minutes, stock certificates, stock ledger, corporate seal, etc.

That fee for a "resident agent" applies to a business incorporating in one state but not a resident therein. A resident agent, often the firm incorporating you, fulfills the residency requirements and accepts legal service as required by the state. Each year the agent will charge you a fee, about $85 annually.

When to Switch

When should you consider changing the corporate form of your business? A change in structure can benefit a growing company, boost an owner’s income or help in raising capital.

Of course, you could probably raise your credit line or bring in some informal investors with your present business format first. But if you want to attract venture capital or have a public stock offering, you’ll need full corporation status.

If you’re exploring incentive compensation, C status will make it much easier to set up a stock-option plan. Want to boost personal income? Then consider switching from C to S corporation status, eliminating the double tax on dividends. And if you’re diversifying into a new business line, investigate a LLC.

So there you have it, the nuts and bolts on considering your business format, why and when to switch, and the associated the costs and regulations.

But first of all, like we said in the beginning, consult the two "A"s, your Attorney and your Accountant. They can provide the best guidance for your particular business.

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