Why Incorporate Your Business?
Corporate entities are separate from those who founded them and can be independent. A small business has much to gain by transforming into a corporation. They are considered individuals and can have many advantages as well as disadvantages.
Advantages and Disadvantages of Incorporating a Business
There are benefits and drawbacks to incorporating a business. Below are some of the main pros and cons.
Advantages of Incorporating a Business
Some advantages when you are in the process of incorporating a business are you have a shield from lawsuits that affect your business called personal asset protection which protects you from debts and contracts. When you incorporate your business you can experience several tax benefits.
Personal asset protection can make sure your business is safe and personal liability protection is almost guaranteed. You must make a business name to create credibility and secure your company name. When you are on the business name search you must keep in mind that your business name reflects your company.
Tax flexibility is one of the main benefits of incorporation, and C corporations generally have the lowest tax rate. Venture capitals provide a form of equity to small businesses. When filing for their corporate income tax the company can include deductions for certain approved expenses such as salaries, benefits, operating expenses, advertising costs, and travel expenses.
Disadvantages of Incorporating a Business
Incorporating a business brings with it formalities, extra expenses, and more regulations. Formalities such as documentation and audits are mandatory and are strict in most circumstances. A board of directors must help direct the company in the right direction for the individual shareholders.
Becoming incorporated means you must follow much more legal provisions and require expenses that other types of businesses do not. Most states require additional rules and fees when creating a new company.
Types of Legal Entities
There are three main types of formal legal entities that a business can choose from — LLC, limited partnership, and corporation — as well as informal structures like sole proprietorship and general partnership. The structure you choose will depend on the needs of your business and will determine whether or not you need to incorporate your business.
Usually, a sole proprietorship is used for a small business that is run by a single person. In a sole proprietorship, the owner and the company are considered the same for tax purposes, and the company's profit and loss are reported on the owner's individual tax return. Unlike other business types, you do not need to file official formation documents with the state in order to form a sole proprietorship.
Some small business owners form a sole proprietorship because of their simplicity. However, because a sole proprietorship does not protect your personal assets, this may not be the best choice for many small businesses.
Partnerships are used when a business has two or more owners.
A general partnership is a type of business entity that explains that all entities in the company are shared by the owners. This includes the company’s assets, profits, and financial or legal liabilities. Like sole proprietorships, general partnerships typically do not require any formal registration process in order to conduct business.
A limited partnership also has two or more owners, but only one or more partners are investors in the company. They are not responsible for any of the operations in the company. They are responsible for annual meetings, providing basic information, and raising capital.
A corporation is a business entity that is owned by its shareholders and run by a board of directors. Corporations are separate legal entities from their owners and, similar to LLCs, they provide limited liability protection. Unlike an LLC, they must follow stricter compliance rules that include annual meetings and recordkeeping.
There are two main types of corporate tax structures: C corporations (C corps) and S corporations (S corps). C corporations have tax benefits to issue stock options to employees and reduce capital tax gain for owners. C corps pay tax on their income while S corps have a special tax status with tax advantages. S corporations operate by allowing the shareholders to be taxed for the company’s profits and losses instead of the company itself. An S corporation is similar to an LLC in this regard. An S corporation isn't an entity type, though; it is a tax structure. An LLC can be taxed as an S corp.
The S corp tax structure is similar to a sole proprietorship or general partnership (or just "default LLC tax structure") because businesses can pass profits and losses to the shareholders, avoiding the double taxation that can come with the C corp tax structure.
A limited liability company (LLC) is the most common business structure. It differs from a sole proprietorship by offering personal liability protection for its members. Personal liability protection means that, if the LLC is sued or faces litigation, the members' personal assets will not be at risk.
Customizable tax structures are another key benefit for the LLC structure. LLCs are taxed as disregarded entities by default (i.e., single-member LLCs are taxed like sole proprietorships and multi-member LLCs are taxed like general partnerships), but an LLC can elect to be taxed like a corporation if it chooses. This means that they can receive the tax benefits of a corporation without any of the extra corporate formalities.
Additional benefits include flexible ownership and management as well as simple formation and maintenance. LLCs typically cost less to form than other formal business structures like corporations and typically have fewer compliance requirements.
How to Start an LLC
For most small business owners, an LLC is the way to go. An LLC is simple to set up and protects business owners from personal losses should the business get sued.
To start an LLC, you'll need to do a few things:
- Name your LLC (You can use a business name generator to help you get started).
- Choose your registered agent. You can choose any person over the age of 18 to be your registered agent, but we recommend using a registered agent service.
- File the Articles of Organization with your state's Secretary of State (or equivalent state business division). The articles of incorporation must include: the company name, address, number of shares, names of the in-state registered agent service, and incorporators.
- Create an operating agreement.
- Get an Employer Identification Number (EIN) from the IRS.
- Register for business taxes with the state.
- Create a bank account for your LLC.
- Obtain any necessary business licenses or permits, if applicable.
How to Incorporate Your Business
There are a handful of paths to take in order to incorporate your business; the three best options are incorporating yourself, using a formation service, or with the help of an attorney.
Incorporating On Your Own
The most low-cost way of incorporating your business will be to incorporate by yourself. However, this may prove to be costlier in the long run should you make any mistakes or miss any compliance requirements.
Incorporating Using a Formation Service
Using an incorporation service like Rocket Lawyer can automatically handle the incorporation process and can be much less stressful on your bank account than hiring a law firm or legal attorney. Some companies also provide additional services like EIN assistance, business permit searches, and annual report filing.
Incorporating Using an Attorney
An online business lawyer or attorney can save time and make the process easier than attempting to incorporate your business on your own. An attorney can help with legal advice and be a major advantage to your business by providing legal or financial advice should negligence or loss happen or help with making sure your company is set up correctly.
When creating any new business, you must be prepared for the cost and the paperwork required. An incorporated company has many needs that may. The best business may be an LLC as it is easy to start, has less IRS oversight, fewer restrictions, and still protects the business owner from personal loss caused by negligence or losses brought on by the business.
Regardless if you're starting a corporation, LLC, or a limited partnership, it is still advisable to use a formation service to ensure you set everything up correctly and legally.
Frequently Asked Questions
What is double taxation?
Double taxation is the profit of a corporation that is taxed to both the corporation and the shareholders.
What type of business is a nonprofit?
A nonprofit corporation is a type of business that does not distribute any profits to its owners, shareholders, or employees.
What do I need to know before incorporating my business?
Before incorporating a business, you'll need the company name, address, and the names and addresses of the directors, officers, and/or incorporators.