A “C” corporation may be defined as a group of one or more persons
acting as a unit, that unit vested with its own legal and tax identity.
Within the narrow focus of this discussion, it should be noted that an agent who is
incorporated is not the same thing as a corporate agency. Nor is it the same thing as an
incorporated agency. Virtually anyone conducting a business may decide to conduct it
within the corporate form. A separate and distinct concept is that of the corporate agency
within the agency contract is between the insurance company and an incorporated entity.
More will be stated on this concept later.
Legal and tax status
Legally, a corporation is its own entity, separate from either
the owners or managers. In other words, the corporation can sue in its own name or be
sued, own property, and be a participant in virtually any legal proceeding or relationship
which is available to an individual or partnership.
In as much as a corporation is a separate legal entity, it is also controlled by the
laws of the various states. In order to be incorporated, a business or its founders must
seek a charter of incorporation from a government body. To do this, various forms need
to be submitted with the appropriate fees. Various states impose requirements on
corporations. Certain legal “formalities” must be maintained as well as annual filings
and fees.
When you own a sole proprietorship, your assets and the proprietorship’s assets
belong directly to the individual. However, corporate assets do not belong directly to the
owners of the corporation and vice versa. Although an individual may own corporate
stock and therefore the corporation, it is not the same thing as saying the individual
directly owns the corporate assets. These issues of corporate formalities become fuzzy in
the corporate world. However, it is good advice to be aware of these distinctions and
formalities and to comply with them. Many of the tax and legal benefits of incorporation
are available only if the owners are willing to comply with the rules and regulations
concerning the operation of the business within the corporate form.
A “C” corporation is also a separate tax-paying entity. This means it files its own
tax returns in its own name. A corporation is allowed to take deductions where
appropriate and it pays an income tax.
The agent who is thinking of incorporating his practice, must consider various
issues. The tax status of commissions, renewals and service fees on business written
before incorporation must be considered and understood. Likewise the tax effect on
commissions, renewals and service fees on business sold after the date of incorporation
must be understood.
Can income be earned in the agent’s name and then assigned to the corporation?
Can the income be assigned to the corporation before it is earned through some
contractual arrangement between the agent and the corporation? Will the insurance
company recognize the agent’s corporation as the “agent of record”? Will the insurance
company ever contract with a corporation?
Advantages
Limited liability. In most closely held corporations, this advantage of
incorporation is overrated. The theory is that business conducted within the corporate
structure will insulate the owner from liability beyond the assets of the corporation.
However, practically speaking, adequate liability insurance will protect the corporate
owner or the sole proprietor alike. In addition, when large borrowing occurs, most
lenders require owners of closely held corporations to sign the note individually as well
as corporately. This effectively makes the signor liable for the loan to the extent of
his/her personal assets.
Most agent’s businesses do not entail a large accumulation of assets (e.g.,
buildings, machinery and equipment). Thus, the corporate structure may provide a degree
of limited liability particularly in the area of malpractice.
Transferability of interest. The corporate form allows the transfer of ownership
interest through the sale or “gifting” of stock. If the nature of your practice is such that it
may be bought, sold or divided among successors, this point may have some practical
advantage. For many, however, there is no intention that the business should be
transferred or divided during the lifetime of its owner. In fact, it is often not intended that
the business survive the owner. In these situations, transferability of interest is of less
current concern.
Retirement and benefit plans. A number of benefit plans are available only to
corporate employees. These would include corporate life, health and disability insurance.
Whether this benefit is meaningful to you will depend on the level of benefits you
currently enjoy as an agent with one or more insurance companies.
In the area of retirement plans, recent changes have tended to equalize
contribution and benefit limitations between corporate and non-corporate plans. Thus,
one of the major incentives to incorporate has been substantially mitigated. However,
various benefits still point toward the preference for the corporate qualified retirement
plan although the importance given them in the decision to incorporate or not to
incorporate would depend on individual circumstances.
Qualified plan borrowing. As previously mentioned, limited borrowing from a
qualified plan is allowed for corporate owner/employees but not for sole proprietors or
partners.
Minimum pension amount. IRC Section 415[b] [4] allows funding for a minimum
pension benefit of $10,000 regardless of income. This may allow a significant tax savings
for the agent who funds this benefit for a spouse. The spouse must be an employee, but if
your pension plan allows, the required hours can be quite limited.
Section 401[k] plans. These popular plans are available to corporate
owner/employees.
Corporate agents. With a true corporate contract the corporation itself holds the
contract with the insurance company. Service fees are, therefore, paid as long as the
corporation exists and the policy remains in force. Transferability is more simple since change
of corporate personnel will not affect the insurance company or compensation. However,
some companies may not enter into this type of agreement. As you get older you may sell
policies to a young clientele and have service fees paid beyond your death. A corporate
form will not lose this income.
Public relations/psychological benefits. Many agents feel there is an “aura” of
stability and prestige attendant to the corporate form of business. An agent may take the
title “President”. Further, the structure may imply greater resources.
Multiple businesses. Some agents are active in a number of different business
ventures. The corporate form may be prudent to protect the agent’s personal and other
business assets from the dangers of liability or financial loss in a speculative enterprise.
Tax advantages. Historically the tax advantages of incorporation for any small
business or professional practice have hinged upon the existence of a high personal
income tax rate, a medium corporate income tax rate and a low capital gains rate.
Therefore, dollars that would otherwise be taxed at the high individual income tax rate
were retained within the corporation and, eventually, the corporation was sold or
liquidated allowing these accumulations to be received by the corporate owner at the low
capital gains rate. Recent tax changes have effectively lowered the individual income tax
rate so that the difference between the maximum corporate and maximum individual
income tax rates differ by only a small amount. However, you should be aware of the
differentials that exist between the capital gains tax rate and personal income tax rates.
Planning opportunities come and go depending upon changes to these rates. Be sure to
check with local tax professionals regarding current law.
Further, since the top corporate and individual rates are similar, unless current
corporate income can be deferred in a tax deferred manner, the spectre of double taxation
must be appreciated by the corporate planner. Yet the first dollars of income are taxed at
a lower bracket, than the last dollars on a personal return.
Disadvantages
Double taxation. The single greatest negative to the corporate structure is double
taxation. The corporation is an individual tax-paying entity and income earned in excess
of expenses by the corporation is taxed by the federal and state governments. Then, when
this net income is paid out to the corporate owner in the form of dividends, it is again
taxed at the shareholder level. Corporations are viable from a tax perspective because
owners are able to withdraw substantial portions of corporate earnings as salary which is
deductible at the corporate level. In addition, corporate and other benefit plans provide a
sufficient haven for the remaining corporate income so as to make the long term tax and
wealth accumulation picture desirable. Finally, the corporation assets (e.g., real estate or
good will) may substantially appreciate in value over time and may be received by the
corporate owner at the time of sale or liquidation at the reduced capital gains rate.
Increase costs. Operating within a corporate structure will entail various
organizing expenses, fees and taxes. In addition, there will be ongoing costs which are
likely to be greater than in the sole proprietorship or partnership structure. These
expenses will decrease in effect as business increases.
Requirements of corporate form. As alluded to earlier, it is necessary to maintain
a certain formality in the operation of a corporation. Commingling of corporate and
individual assets is unwise. Treating corporate assets as personal assets is unwise. Board
of directors meetings should be held regularly and corporate minutes should be kept.
These lead to a degree of time and expense which should be understood to be absolutely
necessary.
Less flexibility. A corporation is less flexible in operation than the sole
proprietorship or partnership. Simply taking money out of the business entails a degree of
tax complication that does not exist with the other forms of business. This disadvantage
can be turned into an advantage if experience and thorough legal and accounting advice
is sought by the agent at the time of incorporation. This would allow the corporation to
be structured in a manner which facilitates growth through change in business operation
with a minimum of expense complication.
Potential loss of benefits. You must determine if incorporation will cause you to
lose eligibility for various insurance company retirement, income deferral and other
benefit plans.
