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Double Incorporation Strategies
By: Richard A. Chapo, Esq.

The stated goal of the corporate planning is to create an asset protection barrier between your business activities and personal assets. Regardless of the type of business you conduct, there is a significant risk of being sued in our litigious society. Lawsuits can range from claims of negligent services rendered to defective products to disputes with employees. Incorporating is a means of guarding against these potential threats.

Single Incorporation - Protecting Your Personal Assets

Incorporating your business can essentially be viewed as a means of insuring your personal assets against the risk of lawsuits. If the corporation is created and maintained correctly, it will create a wall between your business activities and your personal assets. Specifically, any lawsuit against your business will be restricted to a recovery against the assets of the business, not your personal assets. For example, if you sell widgets and are subsequently sued because the widgets have a defect, any judgment against the business will only apply to the business assets. Your residence, retirement, stock portfolios, etc., will not be subject to collection.

There are over 100,000 attorneys in California. If you are conducting business in the state, you are running a huge risk if you do not form a business entity that creates a wall of protection between your business and personal assets.

Double Incorporation Strategy - Protect Your Business Assets

Many businesses can benefit from pursuing a double incorporation strategy. The strategy is designed to address the situation where a business has significant assets that are exposed to litigation risk. Taking our defective product example above, it is all well and good that your personal assets are not at risk. But what if your business has a number of high value assets such as manufacturing machinery, office equipment, intellectual property or other items? Merely incorporating your business will not protect these assets because they are owned by the business entity. Since a successful lawsuit would result in a judgment against the business entity, all assets of the business could be seized as part of the judgment. In short, you lose your machinery, office equipment, intellectual property or any other item of tangible value. There double incorporation strategy prevents this from occurring.

The double incorporation strategy involves the creation of two business entities. The first is for your "at risk" business that interacts with customers and the general public. A second entity, a "holding corporation", is then created to own the valuable assets of your business operation including items such as the intellectual property, machinery, office equipment, etc. This holding corporation will then lease the relevant business assets to your "at risk" entity. If the "at risk" entity is sued, the holding company merely recovers its assets and the plaintiff is forced to settle for pennies on the dollar because the "at risk" entity has few assets. In essence, the plaintiff is left with a scenario in which they have won the battle, but lost the war.

Using the double incorporation strategy is an effective means for holding off the 100,000 plus attorneys in California. There are other advantages as well.

Double Incorporation Strategy - Tax Planning Strategies

What does every business owner do at the end of the year if they are going to show a profit for the tax year? They make every attempt to maximize the business deductions! The only problem with this approach is the fact that you are paying money out to other businesses. This need not be the case.

Using the double incorporation strategy, you may be able to pursue significant tax savings. The reason for this is the unique legal and tax stance of "C" corporations. Historically, "C" corporations have received a bad reputation when it comes to tax issues. The argument against using "C" corporations is that the shareholder is faced with double taxation. Specifically, the corporation must pay tax on profit and then the shareholder must also pay income tax when the remaining profit is distributed to them. While technically true, you must understand that even minimal business planning should result in the "C" corporation showing little or no taxable profit, thus eliminating the double tax concern. If you currently have a "C" corporation and are paying significant taxes on the profit, you are being given less than stellar legal or tax advice.

The primary tax advantage of a "C" corporation lies in the fact that the entity can select a fiscal year-end other than December 31st. The fiscal year-end represents the one-year period when taxes must be reported and paid. For example, if you select a June 30 fiscal year-end, your corporation will be required to report and pay taxes for the period between July 1st and June 30th each year. So, how does this help you from a tax perspective? Let's look at the following example.

We form two "C" corporations for you. The first will be your primary business while the second will be a marketing or holding company. The primary business will have a taxable year-end of December 31st, while the marketing/holding company will have a taxable year-end of June 30th. In November 2004, we determine that the primary business will show a profit of $50,000. The primary business will then pay $40,000 to the marketing/holding company for marketing and leasing services. Since this is an allowable business deduction, the taxable profits of the management company are reduced to $10,000 and taxes are paid at a rate of 15% of profit, to wit, $1,500. As June 30th approaches, the taxable profits of the marketing/holding company will be determined and money will be paid to the primary business for services rendered, etc. This will serve to reduce the taxable profit of the marketing/holding company and, again, limit the taxes paid. This process continues year after year and you save tremendous amounts of money on taxes.

The above example is a very simplified version of what actually occurs. In reality, we perform an analysis of your current business activities and design a plan that takes into account your unique business practices, revenues and expenses. All transactions between the entities are verified by contracts and invoices, which are paid at rates similar to what you would find in the general market place. If this appears confusing, simply think of the process as one where you are expensing items at the end of the year, but paying them to an entity you control versus a third party.

Many business owners look into incorporation because they have a general feeling that they should. Few understand the real reasons for do so or the asset protection and tax advantages that can be pursued. If you are interested in learning more, do not hesitate to contact us. Initial consultations are always free, so you have nothing to risk other than your time.

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Richard Chapo is the lead attorney for SanDiegoIncorporate.com, based in San Diego, California. He can be contacted at Richard@sandiegoincorporate.com. or 619-992-1867. This article is for general education purposes and does not address every facet of the laws surrounding the subject. Nothing in this article creates an attorney-client relationship.