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Incorporating Your Business - Is It the Best Choice?

written by: Audrey F. Henderson•edited by: Jean Scheid•updated: 5/18/2011

As a new entrepreneur, you should carefully consider the advantages and disadvantages of incorporating your business. Incorporation establishes a company as a separate legal and tax entity. This limits your personal liability, but also carries potential drawbacks of which you may not be fully aware.

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    Incorporation and Business Structure

    As you establish the legal and financial structure of a company, you will probably consider the Ampex Corporation -- Wikimedia Commons advantages and disadvantages of incorporating your business, as opposed to sole proprietorship, partnership or some other type of company. This article provides general descriptions and explanations of categories to consider in relationship to incorporating a business. Please consult a tax attorney or accountant for specific legal and financial advice.

    A corporation has separate legal and financial status from its owners and officers in the eyes of the law and the IRS. A corporation may sue and be sued, and must file its own income tax returns. For-profit corporations issue stocks and pay out part or all of their profits as dividends to stockholders. Not-for-profit corporations do not have profits per se, instead, their surplus funds must be directed toward furthering the stated mission of the corporation through increased services, improved facilities or similar upgrades.

    A C corporation is the most common form of corporation. A C corporation may range in size from a small business to an international conglomerate. An S-corporation establishes its charter in the same manner as a C-corporation. Like a C-corporation, an S-Corporation is a separate legal and tax entity. However, S-corporations are domestic corporations only. S-corporations are also limited by the IRS to no more than 100 shareholders and may issue only a single class of stock. A Limited Liability Company, or LLC, is not a corporation in the strict sense of the term. It is not a separate legal or tax entity, does not issue stock and does not have a board of directors. However, the members of an LLC do enjoy some protection against personal liability for the actions of the LLC.

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    The Process of Incorporating a Business

    Each incorporated business must register with the Secretary of State's office for the state in which the corporation is registered; some states use a Corporation Commission. To do so, you will need to provide the Articles of Incorporation (or whatever name your particular state assigns) for the business. Each state has its own set of requirements and regulations; consult your Secretary of State website or give the office a call before you proceed. You must also provide the official registered name of the corporation and the federal tax identification number assigned to the company by the IRS. If your state requires it, you must also apply for any necessary licenses or permits along with the initial stock certificates for the corporation at the same time you register the corporation.

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    Advantages of Incorporation

    As a new business owner, incorporating your business has several advantages, especially for businesses seeking funding from venture capitalists or other public financing, Bankrate.com states. In addition, corporations always have the option of selling stocks to raise needed funds. The officers of a corporation must pay personal income tax only on their wages, bonuses and stock dividends. Any other profits are assigned to the corporation, which are nearly always taxed at a lower rate than the tax rate for individuals.

     

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    Is a Corporation Right for You Because a corporation is a separate legal entity, its owners and officers are shielded from personal financial and legal liability for the majority of the actions of a corporation. Shareholders can only be held liable for the value of the stock they hold in the corporation. Unlike a sole proprietorship or a partnership, a corporation may continue into into perpetuity as long as it remains financially solvent or does not run afoul of the law. Evaluating the assets of a business before a transfer of ownership is much less complex for a corporation than for a sole proprietorship, where personal and business properties are often commingled.

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    Disadvantages of Incorporation

    Structuring your company as a corporation is not always advantageous. There are both advantages and disadvantages of incorporating your business. On of the major disadvantages of a corporation stems from its existence as a separate legal and financial entity: double taxation. That is, the corporation pays taxes on its profits. However, the corporation also distributes profits to stockholders in the form of dividends, which stockholders must declare as income on their individual federal income tax returns. S-corporations avoid double taxation, however, insurance companies, financial institutions and other categories of companies are prohibited from forming S-corporations, even if they otherwise qualify under IRS regulations.

    Corporations are also more expensive to establish than other business structures. The costs involved may be prohibitive for small business owners. The administrative burden of board meetings, minutes and issuing dividends is another disadvantage to consider. Many small business owners would be better served to consider structuring their businesses as a Limited Liability Company, at least in the beginning stages, Bankrate.com advises. LLCs are not subject to double taxation, although the members of an LLC receive a K-1 from the business tax return showing any profits or losses--the K-1 must be filed with the member's personal tax return.

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    References

    • Business.gov: Business Incorporation, at http://www.business.gov/register/incorporation/
    • Business.gov: Corporation, at http://www.business.gov/register/incorporation/corporation/
    • Business.gov: Limited Liability Company (LLC), at http://www.business.gov/register/incorporation/llc/
    • Business.gov: S-Corporation, at http://www.business.gov/register/incorporation/s-corporation/
    • Business.gov: Steps to Registering a Business, at http://www.business.gov/register/steps-to-register.html
    • Dan Weil. How to Structure a Small Business, in Bankrate.com, retrieved at http://www.bankrate.com/finance/money-guides/how-to-structure-a-small-business-1.aspx
    • IRS.gov: Business Structures, at http://www.irs.gov/businesses/small/article/0,,id=98359,00.html
    • IRS.gov: S-Corporations, at http://www.irs.gov/businesses/small/article/0,,id=98263,00.html
    • IRS.gov: State Links, at http://www.irs.gov/businesses/small/article/0,,id=99021,00.html
    • Small Business Administration: Incorporating Your Business, at http://www.sba.gov/content/incorporating-your-business

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