TO INCORPORATE OR NOT TO INCORPORATE
by John Graden
John Graden's new book, The Impostor Syndrome
Click for John Graden's two minute bio from
American Martial Arts Masters Documentary
The Sole Proprietorship as a Form of Business Organization
A sole proprietorship essentially means that you
are the business. You and your school operate as one entity. You
are the sole owner (hence, the name sole proprietorship). The sole
proprietorship is the simplest business form of operating your
The sole proprietorship is a popular and frequently
used form of business organization. When your school is organized
as a sole proprietorship, the business entity and your other affairs
(personal and business) are merged together. As the proprietor,
you own and control the business. From the standpoint of nearly
all legal rights and responsibilities, your sole proprietorship
business and you, as the proprietor, are considered to be one and
When a business is owned and operated by a wife
and husband, it is often not clear whether the operation is a sole
proprietorship or a partnership. The distinction between a sole
proprietorship and a partnership can be very important. If you
have a sole proprietorship owned and operated by you and your spouse,
ask your attorney to clearly identify the legal implications of
the linkage between your personal and business affairs. Your attorney
also can describe actions you can take to ensure that you have
whatever the highest level of liability protection possible in
All debt incurred on behalf of the school is payable
by you, the proprietor. Lenders customarily require signatures
on debt agreements by both the proprietor and spouse (if any).
For business and financial management purposes,
it is best to maintain completely separate records for your school
and your family or household. To ensure you have documentation
needed for income tax reporting purposes, itıs highly recommended
to use separate bank accounts and separate credit arrangements
for your business and your family affairs.
If credit is used in your business operations,
itıs particularly important to maintain a separation of finances
and records for your business unit and your household. Interest
payments on personal debt are not a deductible expense for federal
and state income tax purposes, while interest payments on business
borrowing can be fully deductible.
When business and household costs are incurred
jointly (for example: telephone bills when the telephone is used
for personal and business calls, and travel using a personal auto
for business purposes), allocate the respective portions to the
business unit and the household. Then pay the business and personal
amounts from the respective bank accounts. A relatively small investment
of effort in bill paying and record keeping can ensure you have
the data needed for filing and substantiating your income tax returns.
Advantages of the Sole Proprietorship
1. In large part, the advantage of the sole proprietorship
is in its simplicity and flexibility. 2. A sole proprietorship
can be established, modified, bought, sold or terminated very quickly.
3. No business planning or organizational arrangements are required
when a sole proprietorship is established. Of course, that can
also work to your detriment. 4. A sole proprietorship involves
minimal legal formalities and registration requirements to begin
and maintain. 5. A sole proprietor has total autonomy or decision-making
authority. 6. A sole proprietor enjoys all the income of the school.
7. All school assets (equipment, inventory, property, etc) are
owned by the sole proprietor.
Disadvantages of the Sole Proprietorship
1. As a sole proprietor, you are personally responsible
for all liabilities (losses, debts, expenses) created by the school.
Therefore, the sole proprietor is personally responsible for all
contracts and financial responsibilities created by the school
including the actions of the schoolıs employees. 2. If there are
any lawsuits against the school, you will be personally liable
for any judgment. As such, your personal assets, such as your automobile,
house and bank accounts are at risk of being seized by anyone obtaining
judgment against your school. 3. Income or loss from your school
must be included with your other sources of income during the year.
As a result, you may be subject to paying more income tax than
if another method of conducting business is used. However, in some
cases, the ability to apply losses to your personal income may
be an advantage of a sole proprietorship, especially if there are
other sources of income.
C-CORPORATION or an S-CORPORATION
Choosing the Structure That Fits Your Needs
The advantages of incorporating are many. Contrary
to a sole proprietorship, a corporation separates you from the
school. The incorporated school is an entity in and of itself.
When a corporation is created, the shareholders do not own the
business or the property belonging to the corporation. The business
and the property is owned by the corporation and the corporation,
in turn, is owned by the shareholders. In addition, the rights
and liabilities of the corporation are not the rights and liabilities
of the shareholders.
The fact that you can establish an entity that
works and thinks for itself and, if used properly, will stand between
you and may lawsuit settlements is the primary reason why you incorporate.
However, it should be made clear that the corporate shield can
be penetrated to expose the primary officers to liability. Record-keeping
and annual corporate updates with your attorney and accountant
are critical to maintaining the integrity of a corporation.
There are two primary forms of incorporation.
Generally, a corporation is a C-Corporation. The other form of
corporation is the S-Corporation. Each is somewhat distinct and
offer certain advantages for the school owner, depending on your
There is another benefit you expect from your
corporation, and that is tax savings. When you use the C-Corporation
structure, you have, along with some positive tax advantages, a
negative potential for paying income tax twice on the same income.
This is due to the fact that since a C-Corporation
is a separate entity; it is taxed just as any other individual
taxpayer. In other words, when the corporation makes a profit,
it must pay tax on that profit. If you, as an owner/shareholder,
donıt stay well-organized, your corporation may be forced to pay
income tax on profits before it distributes what is left of the
profits and then you pay tax again on your personal share.
The S-Corporation was designed to rectify this
circumstance, and it works quite well for some school owners. The
S-Corporation is taxed much the same as a partnership. That is,
the shareholders pay the income tax on the profits of the corporation.
The S-Corporation is not responsible for paying income tax on its
earnings. The income tax liability on the profits pass through
to the owner/shareholder.
The S-Corporation is not a different entity that
you file for when you organize your corporation in the beginning.
You always form a C-Corporation and then file the proper form with
the IRS (Internal Revenue Service) to do business as an S-Corporation.
This is called and S-Corporation election. The S-Corporation isnıt
for everybody, and you should give it careful consideration with
your tax advisor before choosing the S-Corporation option.
Advantages of a Corporation
1. Limited liability of shareholders. In most
cases, a lawsuit against your incorporated school can only attach
the assets of the school, not your personal assets. This is the
primary advantage to incorporation. 2. Separate taxation of the
corporation from its owners. Possible lower taxation rate. 3. The
corporation can sue and be sued in the corporation name. 4. Using
a corporation provides a more prestigious image associated with
doing business. 5. Perpetual existence of the corporation. The
corporation can continue after the death of a shareholder or withdrawal
of the shareholder by the sale of his/her shares.
Disadvantages of a Corporation
1. Higher initial start-up formalities and cost.
A corporation requires that articles of incorporation be filed,
a head office designated, notice naming
director(s) and officer(s) and a record book (called
a "minute book") must be maintained which contains, among
other information, details of meetings of shareholders and directors.
2. Requires annual maintenance by an accountant and lawyer. A corporate
tax return must be filed and the "minute book" must be
updated. This is critical. Failure to maintain the corporation
in this manner can result in a collapsing of the corporation, creating
liability for you and your family in the case of a lawsuit or debt.
3.. Losses incurred during the start-up years cannot be used to
offset income of the owner from other sources of income.
(An excerpt from How to Open and Operate a
Successful Martial Arts School, by John Graden)
To receive a copy of How to Open and Operate
a Successful Martial Arts School call 800-973-6734 or e-mail