Tim explains why business owners decide to incorporate and the many benefits that come along with it, such as tax savings, increased credibility, and access to the court system. Learn the different options for entity formation and key tips for determining which one is right for you. Tim will also explain how to set up your new entity and which resources can help guide existing and prospective business owners with their incorporation.
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Transcript
Greg Corombos: Hi, I'm Greg Corombos. Our guest this week on Expert Insights is Tim Jensen, manager of customer service at CT Corporation. Today we're going to be discussing business formation. We've witnessed a lot of upheaval for businesses in the past year. But this is actually a pretty good time to start a new business and there are a lot of good opportunities out there. So, if you are planning to start a new business or just thinking about it, there are some important things to remember, especially as it relates to incorporation. And Tim, thanks so much for being with us.
Tim Jensen: Thanks, Greg. It's great to be back with you today.
GC: Well, let's start with a real quick refresher, what is formation or what is incorporation?
TJ: Yeah, this is a question a lot of people have. The term incorporation essentially refers to formally registering a business as a legal entity in the state you're doing business in. This is typically done with the Secretary of State and grants the business legal authority to transact business in the state.
GC: So why should a business owner incorporate? What are the benefits of doing that?
TJ: Yeah, well, there are a lot of benefits to incorporating a business. The biggest reason why many business owners decide to incorporate is to legally separate the assets and liabilities of the business from the owners by creating a separate entity. This is often referred to as limited liability protection, and this protects the personal assets of the owners from any liabilities of the business.
Other important benefits can include tax savings, dependent upon the entity type that is chosen. There's also increased credibility for the business, which can help with access to capital and increased customer confidence.
Lastly, incorporation gives the business access to the court system, which is critical for things such as enforcing contracts.
GC: Of course, for those who are generally familiar with this arena, there are different options for incorporation and entity formation. So, briefly discuss those if you can.
TJ: Yeah, there are a variety of options for entity types, with the most common being C Corporations, S Corporations and Limited Liability Companies, also known as LLCs. Corporations make up about half of all new incorporations, with the standard C Corporations making up 19% and S Corporations making up 32%.
And actually, all corporations are initially registered as C Corporations with a state. And then S Corporations are actually created through a tax filing with the IRS after the formation, which changes the way the corporation is taxed. LLCs make up about 30% of all new incorporations.
GC: Tim, you mentioned a couple of important distinguishing factors there. But what are the key questions to ask or what tips do you have for folks who are really navigating this for the first time to determine the right entity type for them?
TJ: Yes, my advice would be to learn the features of the different entity types and then select the type that meets the needs the business currently has as these things can always be changed in the future down the line if your needs change or the business needs change.
GC Corporations have no ownership restrictions, make it easy to raise capital through stock sales, and offer easy transfer of ownership. But they do have the possibility of double taxation where you're taxed at both the entity level and an individual level on any company profits. And they also face ongoing formalities such as annual meetings and ongoing state fees.
S Corporations have similar benefits to C Corporations, and also have the pass-through taxation with the IRS to help avoid that double taxation. But there are also some ownership restrictions on S Corporations. For example, shareholders need to be U.S. citizens. And there can be no more than 100 shareholders total in an S Corporation. And they also face similar ongoing formalities as C Corporations do.
And for LLCs, they offer flexible ownership and management options. They have fewer of the ongoing formalities than the corporations do, but ownership can be harder to transfer and it's also a newer entity type. So there's less case law out there regarding LLCs right now.
GC: Okay, Tim, let's say I'm an existing, probably new business owner, maybe an aspiring business owner, I now understand the importance of incorporation and have figured out the best entity for my business. How do I actually go about setting this all up?
TJ: Yeah, this is a great question. And, oftentimes, this decision is influenced by both time and money. Essentially, how can a business owner get it done right while spending the least amount of time and money on this? And the good news is there are several options available to choose from right now.
Oftentimes, the one that makes the most sense is to have the business owner first get educated on the process itself, the different entity types that we just talked about, and figure out what works best for them, and then seek advice from a professional, such as an accountant or an attorney, if needed, for any of those legal or tax questions that you want to make sure that you get answered before you take this step. And then use an incorporation service to handle the actual state filing to save time and money and ensure that it gets done right.
GC: Now, some may think and it would seem obvious but it's not, that the process ends once you've incorporated. You've got your legal protection in place. Okay, great. I've got this all done. But there are some important follow-up steps to be aware of. So what are those?
TJ: Yeah, this is an area I often see new business owners struggle with, they kind of get that, “Hey, I'm formed, I'm ready to go now” and don't always know what else needs to be done. In order to maintain the benefits of incorporating, such as the limited liability protection we talked about, it's important to keep up with any of the ongoing formalities that are required for your business.
Things such as holding and properly documenting the initial annual meetings, filing annual reports with the state, and maintaining a Registered Agent are all important things to keep the business in good standing with the state so you can take advantage of those benefits.
GC: Anything else we should keep in mind?
TJ: Yeah, incorporation happens at the state level, as I mentioned, but many businesses also need to have licenses and permits at the county or city level. So if you think about a restaurant or a bar, you know, they may need a liquor license, maybe they need a food service, license, those kinds of things. Make sure to check to see if your business requires any licenses or permits before starting and then renew them as needed going forward.
GC: Very important compliance issues that business owners, when they're just starting up, they have so many things on their mind, this might not be first and foremost. But it really is one of the most important things if not the most important thing.
So what are some good resources to help guide existing and prospective business owners in these areas? And what kind of help do people get with experts like you and your colleagues at CT Corporation?
TJ: Yeah, the point you made about business owners not always knowing what to do, right? They oftentimes just don’t know all these things yet because they're focused on running their business and getting that off the ground and that's where they're experts in.
So you know, Greg, I would say to go to someone who has experience with incorporation, someone you can count on to get your questions answered and get it done right. Our team of experienced customer specialists works with business owners every day and are always willing to answer any questions or point you in the right direction for additional resources, regardless if you’re a customer or not.
GC: Fantastic advice. Excellent information. Thanks so much, Tim, for being here. We appreciate it.
TJ: Thanks Greg for having me again.
GC: Absolutely. Tim Jensen is the manager of customer service at CT Corporation. I'm Greg Corombos, reporting for Expert Insights.
