Like most small business owners, you
probably want to protect your personal assets against financial or legal
problems that may arise in your company. You may also want your small
business to enjoy the benefits of having its own stock. Or perhaps you're
thinking of ways you can better manage taxes. Incorporation can offer all of
these benefits to your business.
You don't have to run a big company to
incorporate. Anyone who operates a business, alone or with others, can do
so. Incorporation has both positive and negative aspects, and you need to
weigh the benefits and costs against your specific needs and priorities. To
decide if incorporation is right for your business, examine the different
types available to you, and consider the following:
What can incorporation do for you?
Tax breaks and limited liability are the reasons most often cited for
incorporating a business, but there are others as well. Here are some of the
Corporations are taxed at a lower rate than private businesses. The degree
of saving depends on the incorporation category a business chooses.
Salaries, bonuses, and education benefits can be deductible for
corporations, resulting in lower taxes. Additionally, items that a sole
proprietor may only partially deduct may be fully deductible in a
A corporation as a whole becomes its own legal entity. This means that the
business is responsible for any debts or financial liabilities it incurs.
If the corporation becomes insolvent or is involved in a lawsuit, the
individual proprietor or shareholder's personal assets cannot be seized to
pay the corporation's debts.
Because the corporation is owned by stockholders, if the proprietor should
die or sell all of his or her stock, the company can continue to operate,
as long as it complies with ongoing state and federal paperwork and pays
the annual filing fees.
Access to capital
A corporation can raise capital through the sale of its stock, which can
be more advantageous than borrowing and paying interest.
Drawbacks of incorporating
Incorporating your business may include some drawbacks. You should consider
these when deciding whether incorporation is right for you:
Not only does the corporation pay taxes on profits, the stockholders pay
income taxes on the dividends they receive. Certain types of corporations,
detailed below, allow you to avoid double taxation.
Incorporating your business can mean more red tape. The initial
incorporation process requires extensive state and federal paperwork.
Major decisions made by directors must be documented, and minutes must be
kept for annual shareholder meetings. Reaping the tax benefits of
incorporation also means filing more complicated returns and keeping
in-depth records to do so.
Types of corporations
There are several kinds of corporations offering their own individual
benefits. The category you choose for your business will depend on your
specific needs. Keep in mind your company's size and priorities when
considering the following choices:
The most common type of corporation, this separate legal entity can be
owned by an unlimited number of stockholders. The owner or stockholder's
personal liability is usually limited to the amount of his or her
investment in the corporation and no more.
A close corporation is similar to a general corporation, but there are a
few differences. Unlike general corporations, close corporations are not
recognized in all states. Where they are recognized, the number of
stockholders is limited to between 30 and 50. In addition, many close
corporation statutes require that directors offer shares to existing
stockholders before selling to new ones. Stockholders are often actively
involved in the management of the company.
Subchapter S corporations
A Subchapter S Corporation is a general corporation that has elected a
special tax status with the IRS after the corporation has been formed.
This type of corporation provides the benefits of incorporation, but
eliminates double taxation. Double taxation occurs when the corporation
pays taxes on profits and the stockholders additionally pay income taxes
on the dividends they receive.
Limited liability company (LLC)
While LLCs are not corporations, they combine many of the advantages of a
corporation and a partnership. With an LLC, the owners can have the
corporate liability protection for their personal assets from business
debt as well as the avoidance of double taxation. However, LLCs do not
have stock, or the benefits of stock. LLCs offer flexibility in the
ownership, management, and organization of the business but often have a
limited life -- not to exceed 30 years in many states.
While it's ideal to use a lawyer to walk
you through the whole incorporation process, your small business may find
this an expensive proposition. Doing some of the legwork yourself can save
you expensive legal bills. Extensive information on the topic is available
if you want to do your own research. You also may find it helpful to use an
online service, which takes you through step by step and aids you in
preparing the necessary paperwork. You can then use a lawyer to make sure
you're on the right track, answer any questions, or handle legal issues that
If you're still unsure if incorporation
is right for your company, a tax attorney can help you decide. Your choice
of corporation type will depend on your business's needs, size, and
priorities. If you choose well, incorporation can help you save money on
taxes, protect your personal assets, and enable your business to endure the
test of time.