This weekend I participated in an event aimed at professional athletes interested in building businesses and investments. I had the opportunity to present a quick run-down of the basics of incorporating. I shared with them the why’s of setting up a basic business entity (corporations and LLCs), as well as the why’s of setting up those business entities in Nevada.

Many of the athletes already had business entities in place, but most of them had no idea that they were supposed to do anything with the entity after the initial setup.

This is a subject that seems to surprise a lot of people that I meet.

The Internet is filled with places that you can file a corporation or LLC. You pay a nominal fee, you get a pile of paperwork, and ta-da! You have a corporation or LLC!

What many of these companies don’t tell you is that the job is not complete just because you filed some paperwork with a Secretary of State.

What Else Is There?

Most of us know that we have to keep receipts for our accountants. We know that we should keep copies contracts and so forth. We can even find out some info about holding annual meetings. But after that, it all becomes sort of a blur.

The responsibility of maintaining a corporate entity does not have to be scary or difficult, but it does need to be addressed.

“Why??” You Ask

The internal record keeping of any corporate entity is how we show the decision-making process of that entity.

Remember that a formal legal entity separates the business from the owners and the officers of the entity. We set up entities to run our business, so that we have a bubble around our business that shields us from lawsuits against the business, and so that we can save money on taxes. (If you have questions about those basics, read Corporations vs LLCs Simplified.)

The bubble around our business, or the formal entity, is a legal being that stands on its own. That entity, though, cannot do anything until you tell it what to do.

What is Internal Record Keeping?

Internal record keeping is the way that you tell the entity what to do with meetings, minutes, and resolutions. It’s what we call Compliance.

The process goes a bit like this:

You have some action you would like your company to take, for example, to buy a new computer.

When your business was set up as a sole proprietor, you would just run over to the Best Buy, pick out a computer, and pay for it with a check from your checking account. You would then simply log the purchase in your checkbook or give the receipt to your bookkeeper.

The accountant will count that purchase in the list of expenses you have for the year and make the necessary adjustments on your personal tax return. It’s as simple as that.

Not So with a Corporation or LLC

For that same computer, the entity will send out a notification to the necessary officers of an upcoming meeting to decide on whether or not to buy a computer.

At the meeting, the officers vote on whether or not to buy the computer. If you vote “yes”, you “resolve” or make the formal decision to buy the computer. You sign the minutes, put it in the company records book, and then you go buy the computer using entity funds. After that, the entry is made into the bookkeeping and the write-off is taken at tax time, just like with a sole proprietor.

What Difference Does It Make, You ask?

Many of us with a small business hold all of the positions in our companies, or have only a couple of other family members or friends in the entity. It may seem like it won’t ever make a difference if we follow this formal process of meetings and minutes and resolutions.

And Maybe No One Will Ever Know

The risk you take is bigger than you think. The two most important times when the formalities of your entity can be questioned are if you’re ever audited by the IRS and if you’re ever in any kind of a lawsuit.

Those are pretty big times to not have the formalities of your entity in place.

What Could Happen?

Remember, the entity is a separate legal being. That means it’s like another person, separate from you. If you go buy that computer with company dollars from the entity, but you didn’t formally tell the entity that it’s okay to do so, it looks like you’re acting just like yourself, and you just happened to use the entity’s checkbook to do so. Now it looks like you’re using the company as a sole proprietor would.

The IRS doesn’t like that at all. They call that acting like an alter ego. The possible repercussion is that they can say that the money that you made within the entity and the write-offs that the entity took against that income is actually income you personally should be taxed on, all because you treated it as a sole proprietor would treat it.

You then will have more income on your personal tax return. If it’s a previous year (typically the case with audits) you will not only be paying the additional taxes that you personally would have paid if the income was originally on your personal tax return, you will also be paying penalties and interest, because now you are late!

What About a Lawsuit?

In a potential lawsuit, the attorneys for the party suing you will ask to see the corporate records book. They will be looking first to see if you ever got around to issuing your stock (if you didn’t, you don’t have a legal entity). Then they will be looking to see if you did all of that paperwork to show that the entity is separate from you. If you have not followed this formal compliance, once again you will be seen as acting through the entity as an alter ego. Once they show that, the entity will be disregarded and you will be sued personally.

That means that the bubble you put around your business did nothing for you or for protecting your personal assets from litigation.

How to Learn the Process

The formal process of your entity is not rocket science, but it does need to be done. You need to learn to maintain the integrity of your entity. You can find books and programs and all kinds of stuff on the internet to learn how to follow the process, but you must figure out how to follow the process and then be responsible and follow it.

Otherwise you are wasting your time and efforts.

NexStep Innovations LLC has a number of terrific Compliance Programs if you need help in maintaining your entity’s integrity. Contact us and schedule a Compliance Review today.

“What records do I keep?”, “How do I keep each type of record?”, and “How long do I keep each type of record?” are questions clients ask all of the time.

Our accounting team regularly helps business owners with guidance on good record maintenance.

We’re all trying to control our costs and liabilities through good record keeping.  In my business, I aim to make record keeping as efficient as possible, so that my whole team can keep up with what’s going on with each client.  It’s a lot to think about.

You can see one great article that my head accountant John Murray keeps showing to me as well as our clients by clicking here.  It has a great chart of the type of record and how long to keep it, as well as which ones can be kept electronically.

Most of us know that we should keep our receipts and our employee records.  We know that the IRS and other governmental agencies could ask to see this stuff.

Have you thought, though, about what happens if a lawsuit comes up against you or against one of your customers?  Did you know that records you keep can be demanded for a lawsuit, not only against you, but against you clients?  Your records can be subpoenaed.  Keep that in mind when you keep records longer than necessary.

Keeping records is important, but so is regularly destroying records on a regular schedule, as well as how you destroy them. Invest in a shredder or look into a paper destroying service.

I have a CPA friend in Arizona who visits a local paper mill; he watches as his old documents are put into the paper pulping machine.  The paper mill gets free product to recycle, and he gets his documents destroyed for free. His old un-needed tax documents are turned into toilet paper.

Hopefully this will help you out with the general rules of thumb on record keeping, but as always, do not hesitate to give us a call if we can help you as you implement your plans.