If you have a new business idea or are currently operating as a sole proprietorship or general partnership, you may be wondering if incorporation is the right choice for you. Learn how the benefits of incorporating can outweigh the potential drawbacks.
What Does It Mean to Incorporate Your Business?
Incorporating a business means creating a separate legal entity that exists independently of its owner or owners, known as shareholders.
A corporation, whether an individual or an organization, can conduct business, sign contracts, own property, and more. However, incorporation also comes with legal responsibilities, such as filing taxes and submitting annual reports.
To incorporate, you must file “articles of incorporation” with a state agency. These documents outline details about your business, including its purpose, location, and any issued stock or shares.
What Are the Benefits of Incorporating?
Incorporating offers several advantages for both the business and its owners. Here are some key benefits:
Protecting Your Personal Assets
One of the biggest benefits of incorporation is limited liability protection. This means that business debts and lawsuits generally cannot be collected from an owner’s personal assets, such as their home or car.
(Note: Limited liability protection is also available for LLCs but not for sole proprietorships or general partnerships.)
Tax Advantages
Corporations may qualify for tax benefits, such as deductions for health insurance premiums, self-employment tax savings, and life insurance. If your corporate tax rate is lower than your personal tax rate, or if the corporation does not distribute income to shareholders, there may be additional tax savings.
Business Growth and Longevity
Incorporating can make your business more credible, attracting more customers and business partners. Additionally, a corporation continues to exist even if an owner passes away or sells their interest.
Easier Transfer of Ownership and Access to Funding
Ownership in a corporation can be transferred more easily than in other business structures (with some restrictions for S corporations). Corporations also have an advantage when raising money, as they can sell stock. Many banks prefer to lend to incorporated businesses.
Retirement Benefits
It may be easier to set up retirement plans, such as a 401(k), for an incorporated business.
Privacy Protection
If you want to keep your connection to a small business private, incorporation can provide anonymity.
What Are the Downsides of Incorporating?
While incorporation has many benefits, there are some potential drawbacks to consider:
Double Taxation
C corporations face double taxation. The company first pays taxes on its profits, and then shareholders must pay taxes on any dividends received. However, businesses can elect S corporation status to avoid this issue.
Fees and Costs
Filing articles of incorporation comes with state fees, which vary by location. Additionally, some states charge ongoing fees that are higher than those for sole proprietorships or general partnerships.
More Record-Keeping Requirements
Corporations must follow specific rules for keeping records, including initial and yearly documentation, which sole proprietorships, general partnerships, and LLCs do not have to follow.
Choosing the Right Business Structure
The structure you choose for your business affects everything from daily operations to taxes and the level of personal liability you take on.
After deciding on a structure, you’ll need to comply with specific rules for formation, management, and ongoing legal requirements.
It’s wise to seek advice from professionals such as a business consultant, tax advisor, attorney, or accountant. You can also use online tools like the BizFilings Incorporation Wizard to help determine the best business type for your needs.
