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The Argument Against Incorporation

written by: •edited by: Michele McDonough•updated: 5/5/2011

Are you thinking about incorporating your small business? While many push the advantages of this type of legal structure, the disadvantages of incorporating are not as heavily discussed. Before making a decision, you should know the facts and then ask yourself, "Should I incorporate?"

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    Introduction

    A corporation is a legal business structure that offers business owners some limited liability features. In some cases, incorporating may offer some tax benefits, though not always. Those who are wondering if they should incorporate will have to evaluate the disadvantages and determine if this is the right business structure to meet their needs.

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    Disadvantages of Incorporation

    Paperwork problems Cost: The cost of doing business when incorporated increases due to added fees and paperwork. The cost of registration itself may be quite high. This business structure, as compared to others, is very complex and thus it is logical that setting it up would be more costly. Apart from this are annual maintenance costs for filing reports due on an annual basis.

    Tax Returns: Incorporation of a small business would mean two tax returns to file annually, which is more commonly termed as double taxation. The filings would include personal income tax filing and corporate tax filings. Not only does this mean additional paperwork and legal formalities, but also as compared to a sole proprietorship, an incorporated company will not be able to deduct its losses from the personal profit of the owner. Moreover, there may be additional costs in the form of legal fees, accountant fees, etc. involved.

    Paperwork: The additional paperwork does not end with tax filings. An incorporated business also needs to take care of detailed books that contain minutes from corporate meetings, reports, register of directors, share register, transfer register, tax return files, audit books, bank account records, etc.

    Personal Tax Credits: Once incorporated, the business may face tax disadvantages. As corporations are not eligible for personal tax credits, every dollar earned is taxed. This is not the case in a sole proprietorship, in which the business is able to claim tax credits.

    Tax Flexibility: An incorporated business does not have the same flexibility in handling losses as compared to other business structures. In the case of incorporated businesses, the losses can be carried back or forward to reduce the income from other years.

    Liability: The limited liability feature is only a myth. This can be undercut by personal guarantees and or credit agreements. When businesses have what lending institutions consider to be insufficient assets to secure a loan, they often ask for personal guarantees. Thus, while technically the business has limited liability, the owners ends up being personally liable if the corporation does not meet repayment obligations.

    Salary: The Internal Revenue Service (IRS) may determine the salary of an employee of the incorporated organization as unreasonable. In such case, they may allow the employee to keep part of it and ask the other part to be given out as dividends to the company shareholders.

    Salary Draws: There are no salary draws allowed once the business is incorporated. Thus, business owners would not be able to draw out money from business bankbooks. All draws made would be in the form of loans and in most cases, a particular rate of interest would also be required to be charged.

    Dissolving: Dissolving or closing down the incorporated business is much more difficult compared to other forms of business.

    When making the decision of whether a business should be incorporated or not, many factors need to be considered. It is advisable to obtain the help of a professional consultant before a decision is made.

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    Resources

    Sources

    1. Small Business Administration Incorporating and Registering Your Business http://www.sba.gov/category/navigation-structure/starting-managing-business/starting-business/establishing-business/incorporating-registering-your-

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