Imagine you’re out golfing with friends as they learn with surprise that you haven’t incorporated your insurance agency. “There are great tax benefits,” they say. “You won’t be liable!”
Are they right? Are you missing out?
Maybe – but it’s not that simple. You should understand some of the nitty-gritty details before ordering a name plate for your C-suite.
What Are My Options?
There are several business structures to choose from, with varying levels of liability protection and tax advantages.
Sole Proprietorship. You and your business are one and the same. You’re exclusively responsible for your company’s assets and liabilities (debt or otherwise). Advantages include: not having to file separate taxes, being entitled to all profits, complete control over decisions, inexpensive to form.
Partnership. You and another partner(s) share in the company’s debts, revenue, operations, and labor. The company itself doesn’t pay separate income tax, as partners include their share of the partnership’s income or loss on their personal tax returns, so there’s no tax savings with this setup.
Limited Liability Company (LLC). LLCs offer the same liability protections as a corporation, but there’s a tradeoff in terms of taxes. On the plus side, you don’t have to prepare complicated corporate tax returns (or pay someone to do it for you). However, you pay taxes on profits at the individual level — usually more than the corporate rate — and you must pay self-employment taxes. It’s also worth noting that some states don’t allow you to use the word “insurance” in your LLC name.
Corporation. There are two types: S or C corporations. Shareholders in either structure aren’t individually liable for the debts or actions of the company. The main difference is how the company is taxed.
C Corp: The company pays a corporate tax rate and files separate returns. Individual shareholders pay taxes again on profits taken as distributions. This is called “double-taxation.”
S Corp: Profits go directly to shareholders and separate company tax returns aren’t needed. You’ll pay individual taxes on the “reasonable compensation” (i.e. salary) required for all shareholders. Any profit beyond that can be reported as distributions, which have a lower tax rate.
(Source: U.S. Small Business Administration)
Which One is Right for Me?
The answer to this question depends on your personal goals for your business.
Choose a Professional Name
A “Doing Business As” name (DBA) will suffice. A DBA is the minimum requirement to market your services under any name but your own – even if it’s just “John Smith Insurance.” However, this doesn’t help with taxes or liability.
Reduce Tax Burden
Consider a standard corporation or LLC with S-corp election. We recommend asking a tax attorney how much revenue you’d need to see savings.
Minimize Personal Liability
First, let’s be clear about what this means. In the insurance industry, you don’t have the privilege of claiming you didn’t know what your downlines were up to. It’s your duty to ensure compliance with state and federal laws, so you can be accountable for misconduct within your company. Now the good news: Incorporating or creating an LLC does protect your personal assets from being up for grabs in a lawsuit. Just be aware that personal assets do not include money you and your shareholders invested in your company or its stock.
The Best of Both Worlds?
Some agents believe they’ve found the sweet spot by creating an LLC with S-corp election. This means you agree to have your company taxed as a corporation, but legally it remains an LLC for all other purposes. This option allows you to benefit from lower corporate tax rates while avoiding other strict regulations. You can also skip the more expensive start-up fees and additional paperwork associated with incorporating.
What are the Next Steps?
The short answer is talk to a tax attorney or CPA. They’re familiar with state-specific regulations, and they can help you decide which structure best serves your business’ goals. If you want an idea of what you’re getting yourself into before scheduling an appointment, here’s a brief overview:
- Prepare required documents. Write your articles of incorporation or articles of organization (for LLCs). This includes things like:
- Official business name you want to use
- Purpose of your company
- Names and addresses of owners
- Office location(s)
- Bylaws describing how your business will run (Not required for LLCs)
- Apply for a charter. This is usually submitted to the Secretary of State’s office or a related department.
- You don’t have to use the same state as your main office, but you’ll need a business address in that state.
- Moving forward, you’ll have to file a “foreign qualification” for each additional state you conduct business in.
- Make it official. Once your articles are accepted, the office you filed with will send you a formal certificate.
- Stay compliant. Obtain the proper business licenses and permits, both state and federal.
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Here’s our straightforward advice: Take your time establishing yourself as an individual agent before starting your own company or choosing its structure. Once you build a solid book of clients and recruit a few good agents to your downline, you can think about taking the next step. Good luck!
This article is meant to offer general guidance, not legal advice. You should talk to your appropriate state office for complete requirements on starting a business. A tax attorney or CPA can also be helpful in determining the best structure for your company.