Taxes

“Should I incorporate my daycare? (Or, any other type of business?)”

Daycare

 

Marion asked me in my Facebook Group Glass City Side Gig Pros:

 “Should I incorporate my daycare?”

My answer:

Yes! Yes! Yes! Yes! Yes!

And in case I was not 100% clear, yes you definitely want to incorporate your childcare business. This answer would be true no matter what industry you were asking about, but because of the fact that any kind of childcare facility can be hit with very substantial lawsuits, you definitely need to incorporate.

A “corporation” is what is known as a fictional entity, or legal entity. What that means is in the eyes of the law, your company is viewed as being a distinct and separate entity from yourself. The reason why this is important is because of the fact that if you are ever sued, a corporation allows you to shield your personal assets from the lawsuit. Let me give you a very brief (and generalized) example of how this operates:

Unincorporated: Your brand-new childcare company has a total of $10,000 in assets. On your first day of business one of your employees decides to share her homemade sushi with some of the kids under your care. Several of them contract life-threatening parasites which require $893,000 worth of medical care to cure them. Lawyers representing the children step in using the legal system, take the $10,000 in assets, and you – personally – are on the hook for the remaining $883,000. Your house, vacation house, boat, and other personal belongings are auctioned off, reducing your remaining debt down to $317,000—and you are bankrupt.

Incorporated: Your brand-new childcare company has a total of $10,000 in assets. On your first day of business one of your employees decides to share her homemade sushi with some of the kids under your care. Several of them contract life-threatening parasites which require $893,000 worth of medical care to cure them. Lawyers representing the children step in using the legal system, take the $10,000 in assets, and… And that is the end of the process. Your company, and not you, is what harmed the children and therefore your own personal assets cannot be attached to pay off the corporate debt. You get to keep your house, vacation house, boat, all other personal assets, and you have precisely $0 you owe on your failed endeavor.

Most states make it very easy to incorporate. In fact, most states that I have looked at have their articles of incorporation online in PDF form for you to fill out, as well as most of them allowing you to fill out the forms online, pay with your credit card, and—TA-DA—you are incorporated. The fees I have seen for this are usually between $100 and $150, although I am confident some states such as New York, Florida, and California probably charge a heftier amount. But in terms of protecting your personal assets from being attached because of your business venture, incorporating – and following the rules of running a corporation – is the cheapest insurance you will ever purchase.

This may sound unfair to people you might harm, but as I was taught in my Corporations and English Legal History Classes in Law School (as well as the Continuing Legal Education classes that I took back when I was a licensed attorney), this protection is put in place to encourage people to start businesses. We know that if this “corporate shield” does not exist, far fewer people are willing to start their own business, and thus our economy overall would suffer greatly. Because government wants a healthy economy, and the tax revenue it generates, we have created the legal concept of corporations as being separate and apart from the people who create the corporation.

The next magic question is whether you want to incorporate as a “normal” corporation or as an LLC (Limited Liability Corporation). These are also known as a “C Corporation” (normal) and an “S Corporation” (LLC). These designations come from the IRS tax code that defines them that way. You will find material online that says S Corporations require fewer formalities, and argue they are geared for smaller businesses. In many states, that distinction is no longer true and many states have gotten rid of many of the formalities which used to be required of C Corporations. Thus, in terms of formalities, for many people there are no differences between a C and an S corporation.

But there is one major difference between a C Corporation and an S Corporation – taxes.

C Corporations are subject to the infamous “double taxation” where S Corporations are not.

Here is how that works:

C Corporation: Your childcare business (or any other business) makes $100,000 in profits in the year 2022. That means your company owes Uncle Sam $21,000 in taxes (and a tax return which can be a nightmare to fill out requiring an accountant). The remaining $79,000 flow to you as profits—which now get taxed again at a price tag of $10,442.  (The actual number would probably vary based upon specific deductions, but these are just “ballpark” numbers.) Your actual take-home pay from your C Corporation is $68,558.

S Corporation: Your childcare business (or, again, any other business) makes $100,000 in profits in the year 2022. ALL of that income flows directly to you, and thus you owe the IRS $15,103. Your take-home money is $84,897.

Difference: S Corp saves you $16,339 in taxes.

Add in the fact that your state and local taxes are usually based off of your federal income taxes, and your company, if it is a C Corporation, might also need to file state and local taxes, and the tax savings for the vast majority of businesses of filing as an S corporation become readily apparent.

Again, I am speaking in broad terms here.  There could be reasons why a person might in fact choose a C Corporation over an S Corporation, or a Limited Liability Partnership, or some of the other company forms which are out there. Probably the vast majority of people would be well served if they incorporated their business as an LLC. Doing a Google search for incorporation in your location is a good starting point, and will probably give you most of the answers you would need. Also, running a corporation does require certain formalities be followed, such as a separate bank account in the full name of your corporation using its IRS EIN (Employee Identification Number). You also need to operate under your CORPORATE name, and there are other nuances, but that is where your homework comes in. Get a good book such as “LLC or Corporation” by Anthony Mancuso, or “Inc. Yourself” by Judith McQuown and read every word.  

As always, the advice I am giving here is not legal advice. If you have any specific legal questions, you should seek out a licensed attorney who is skilled in this area of law.