An incorporated business structure is a legal structure that provides the limited liability feature for a corporation and the tax efficiencies and operational flexibility of a partnership. This legal entity requires businesses to register the business and file certain documents with the government.
Incorporating a small business has both advantages and disadvantages. It is advisable to first weigh the pros and cons of incorporation and then decide whether it is worth or not. Read on to learn more.
Cost: The cost of doing business when incorporated increases due to added fees and paperwork. The cost of registration itself is quiet high. This business structure as compared to others is very complex and thus it is logical that setting it up would be costly. Apart from this are the maintenance costs.
Tax Returns: Incorporation of a small business would mean two tax returns on file annually, which is more commonly termed as double taxing. These would be income tax and corporation tax. 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. The whole process of filing taxes is complicated and complex. Moreover, there are additional costs in the form of legal fees, accountant fees, etc. involved.
Paperwork: The additional paperwork does not end with tax files. An incorporated business also needs to take care of detailed books that contain minutes from corporate meetings, all 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 be led to a tax disadvantage. 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 forms of business. 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 legal organization may term the salary of an employee of the incorporated organization as unreasonable. In such a case, they may allow the employee to keep part of it and ask the other part to be given out as dividends.
Drawings: There would be no more business drawings once the business is incorporated. Thus, business owners would not be able to draw out money from business bankbooks. All drawings made would be in the form of loans and in most cases, a particular rate of interest would also 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.