ABCs of Forming a Wood Flooring Business
By D. Jeffrey Craven
Originally Published in the April/May 2012 Edition of Hardwood Floors Magazine.
Many wood flooring contractors work out of their house. There is nothing wrong with this—when most of your time is spent out in the field, there is no sense in paying overhead for an office seldom used. Just because your house is your “home office” doesn’t mean that you aren’t operating a “real” business, or that you don’t have real business concerns. That said, sometimes it’s still hard to decide when you cross the line from “employee” to “business owner,” and many contractors don’t see the need to treat things differently.
First, how do you know you are your own business? It can start with you receiving cash or personal checks for payment, or when the person hiring you is not withholding money from your payment to pay income taxes. You might also have obtained your own contractor’s license, if your state requires it. Perhaps you use an accountant who has told you to keep track of your receipts for expenses, and you are deducting them on a “Schedule C” for income tax purposes. Maybe you’ve gotten business cards with a business name you have decided to operate under, or maybe you’ve opened a separate bank account for your business. All of these are signs you are not acting as someone else’s employee. Understand that you can do all of this while still working for someone else; just because you receive a paycheck from a particular employer does not mean you aren’t operating a business if you are doing any of the above, even if it’s only for “side jobs.”
Some contractors operate under a business name for years without ever having formed a separate entity for the business; they sometimes even use a business name. When doing this, the business name is referred to as “doing business as” or “dba” for the owner, and it’s a simple way to operate a small business. However, given the ever-rising tide of lawsuits, this may not be the best option. If you operate as a “dba” and you are sued, you will be sued in your personal name. If you lose that lawsuit, the person who sued you can seek payment from you directly and can force the sale of your personal assets to ensure payment.
You might say, “Well, it doesn’t matter because I have insurance.” While it always makes sense to have a business insurance policy to cover potential litigation claims, realize that many business insurance policies contain an exclusion for “your work” and that home insurance policies often do not cover for claims based upon contracts.
By contrast, if you have formed a corporation or limited liability company, under the law that business is a “separate legal entity” from you—essentially, it is its own person. So, if you, as the corporation or limited liability company owner, enter into a contract with a property owner to do flooring work and that owner later sues (for whatever reason), their claim is against the corporation or limited liability company, and not against you personally. If you lose, the company may owe money to that property owner, but you personally will not, and your personal property will be protected. The worst-case scenario is that your business goes out of business (and perhaps files bankruptcy). You may lose your company, but you will not lose your personal belongings. (For more details on forming a corporation, see “In the Inc.” from the October/November 2006 issue.)
There are other reasons to form a separate legal entity for your business. One of these is the ability to transfer the business later. If you decide you want to retire, you can sell your ownership interests in the company to another person. That person would acquire all of your rights to the business name and assets, including the accounts receivable. You can also will your company interest to a family member.
Corp. or LLC?
Basically, forming a separate legal entity for your business is a good idea. But which one should you form, and what’s the difference between the two? The “Corporation” has been around for over 100 years, and it is recognized throughout the United States and in many foreign countries. A corporation has both a board of directors and officers. If you are the sole owner, you would be both the CEO and the president; you would also head the board of directors. A corporation has bylaws, annual meetings and minutes, and resolutions to adopt certain actions. It may have reporting requirements to the state in which it is incorporated. Ownership in a corporation is by issuance of certificates reflecting shares of ownership. A corporation may either be public (or “open”), where the shares are registered with the Securities Exchange Commission (SEC) and may be publicly traded on a stock exchange. Or, a corporation can be private, where the interests are held by a small group of people who are directly involved in the operations of the company.
The limited liability company (LLC) entity was created in the 1980s. The idea was to create a business form that was simpler to operate than a corporation. LLCs are owned by members. The members take ownership via membership interests, rather than shares, and LLCs are generally closed, meaning they are not registered or traded publicly. Usually there are fewer reporting requirements and no specific obligation to have an annual meeting of members. Instead of bylaws, there is an “operating agreement,” which is like a contract between the company and the members. For most contractors, an LLC is the better choice. That said, if your state licenses contractors, verify that it will accept an LLC as an entity choice; presently, California will allow contractors to operate only as corporations.
Death & Taxes
What about taxes? A corporation will either be taxed as a “C” or “S” corporation. By default, a corporation is treated as a “C” unless it elects to be treated as an “S” by submitting the proper form. Most small contractors will want to be taxed as “S” corporations to avoid “double taxation,” in which both the corporation and owner are each taxed on either income. (For more details on these types of corporations, see “The Right Fit” from the October/November 2008 issue.)
An LLC has the further advantage of being able to be taxed as a sole proprietorship or a partnership. In fact, if it has one owner by default, it will be treated by the IRS as a sole proprietorship; if an LLC has more than one owner, it will be treated as a partnership. This means a sole owner can have the advantages of the entity without having to complete separate taxes for that entity.
Of course, this entire process requires some thought. You need to decide whether to form a business, how it should be structured, and how you’d like to be taxed. Operationally, running a business requires more work—maintaining separate bank accounts, writing annual reports, etc.—but, generally, it’s considered smart business.