Whether you’re just considering a new business idea or already act as a sole proprietorship or general partnership, you may wonder if incorporating your business is right for you. Discover why the benefits of incorporation can outweigh any downsides.
What does it mean to incorporate your business?
When you incorporate your business, you are forming a legal entity that exists independently of its owner(s), also known as shareholders.
An incorporated company, individual, or organization can engage in business, enter contracts, own property, and more. But incorporating your business also brings with it legal obligations such as tax filings and annual reports.
To incorporate your business, you must file “articles of incorporation” with a state agency. These articles or formation documents include information about your business purpose, location, and shares and stock issued (if any).
What are the advantages of forming a corporation?
There are many advantages to incorporating to both the business and the owners. Forming a corporation allows you to:
- Secure your assets. One of the main advantages* that corporations have is that the owners enjoy limited liability protection and are typically not personally responsible for business debts. This means that creditors can’t pursue your home or car to pay business debts.
*LLCs also provide limited liability protection; sole proprietorships and partnerships do not provide any liability protection.
- Gain tax breaks. Another benefit to incorporation is that corporations often gain tax advantages and can write off items such as health insurance premiums, savings on self-employment taxes, and life insurance. If the corporate tax rate is lower than the personal rate and/or your corporation does not distribute income to shareholders, you may also realize additional tax savings.
- Grow your corporation for now — and the future. Incorporating bolsters credibility and may help you reach potential new customers and partners. And while you can’t live forever — your corporation can. Even if an owner dies or sells interest, the corporation still exists.
- Easy transfer and faster funds. Corporation ownership can be easily transferable (with some restrictions on S corporations). Capital can be raised more easily through the sale of stock. Another incorporation advantage is that many banks prefer handling loans with incorporated borrowers.
- Ready for retirement. Retirement funds and qualified plans, like a 401(k), can be easier to establish.
- Gain anonymity. If you don’t want your involvement with a small business to be public knowledge, your best choice may be to incorporate.
What are the disadvantages of incorporating your business?
Corporations do have some potential disadvantages, including:
- Double taxation. When corporate profits are distributed as dividends, C corporations are subject to double taxation. Corporations are liable for reporting and taxing business profits first. Any remaining profits distributed to shareholders in the form of dividends must be reported as personal income by shareholders and taxed accordingly. The IRS allows companies to elect S corporation tax status to avoid this disadvantage.
- Ongoing fees. You must file articles of incorporation with the state which comes with varying fees depending on the state. Many states impose ongoing fees — which are steeper for a corporation than for a sole proprietorship or general partnership.
- More record keeping. Corporations must follow initial and annual record-keeping requirements—which sole proprietorships, general partnerships and limited liability companies (LLCs) avoid.
Choosing a business structure
Your choice of business structure can impact everything from daily operations to taxes and risk exposure of your personal assets.
Once you’ve chosen a structure, you must also address unique formation, management, and compliance requirements to be met.
It’s a good idea to consult with a professional, such as a small business counselor, tax advisor, attorney, and accountant. You can also use this BizFilings Incorporation Wizard Tool to see which business type is right for you.
For more information, read: Comparing company types: Understanding C Corp, S Corp, LLC and DBA business structures.
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