How to Incorporate Your Small Business

Most small to mid-size business owners may feel Incorporating their business isn't necessary, or it's something only "big companies" do - - wrong!

There's so many scenarios happening each and every day putting businesses "Out of Business". Don't put yourself in that situation - be safe, not sorry!

Incorporating isn't difficult and it isn't even expensive. A one-time investment will save you money in the long term, and incorporation allows you to to operate your business without the fear that someday you might lose everything to one disgruntled and complaining client or customer who decides to file a lawsuit.

Most one-person home businesses, small businesses, home businesses incorporate as an LLC.

The Benefits of Incorporation

• Secure your assets, gain tax breaks. Corporation owners enjoy limited liability protection, and are typically not personally responsible for business debts. So creditors can’t pursue your home or car to pay business debts. Another plus: corporations often gain tax advantages, writing off such things as health insurance premiums, savings on self-employment taxes, and life insurance.
   
• Grow your corporation for now - and the future. Incorporating bolsters credibility, and may help you reach potential new customers and partners. And while you can’t live forever - your corporation can. Even if an owner dies or sells interest, the corporation still exists.
   
• Easy transfer and faster funds. Corporation ownership can be easily transferable (with some restrictions on S corporations). Capital can be raised more easily through the sale of stock. Another advantage is that many banks prefer handling loans with incorporated borrowers.
   
• Ready for retirement. Retirement funds and qualified plans, like a 401(k), can be easier to establish.

• The cons
  Corporations do have some potential disadvantages, including:
• Double taxation. C corporations are subject to double taxation of corporate profits when income is distributed as dividends. This can be avoided by electing S corporation tax status with the IRS.
   
• Ongoing fees. You must file articles of incorporation with the state, plus applicable fees. Many states impose ongoing fees - which are steeper for a corporation than for a sole proprietorship or general partnership.
   
• More record keeping. Corporations must follow initial and annual record-keeping requirements - which sole proprietorships, general partnerships and limited liability companies (LLCs) avoid.

What is a C corporation?
The standard corporation, or C corporation, is a separate legal entity owned by shareholders. You form the corporation by filing incorporation documents with a state and paying the related filing fees. The corporate structure limits each owner’s (shareholder's) personal liability for the corporation’s business debts to the amount invested in the company by the shareholder.

Who should consider a C corporation?

• May need venture capital for financing.
• Want flexible profit-sharing among owners.
• Want company earnings to stay in your business so that it can grow.
• Want flexibility to spread the business earnings between the corporation and shareholders for tax-planning purposes.
• Want flexibility to set salaries for employees/owners to minimize Social Security and Medicare taxes.
• Want flexibility to provide (through the corporation) substantial health and medical benefits and other fringe benefit programs for things like education, life insurance, and transportation costs.
  Want to be able to easily sell your business.
• Want to provide an accountable plan for travel & entertainment.
• Want to be able to offer stock options to employees.
• Expect your business to own real estate.
• Prefer to lower your risk of IRS audit exposure , since there is a higher audit rate for business income that is reported solely on Schedule C of Form 1040 (U.S. Individual Income Tax Return).

Who should consider an S corporation?

• You want to take advantage of benefits that the corporate business type holds, but you want to take advantage of pass-through taxation.
• You want flexibility to set salaries for employee/owners to minimize Social Security and Medicare taxes.
• Flexibility of accounting methods is desired, because corporations must use the accrual method of accounting unless they are considered to be a small corporation (with gross receipts of $5,000,000 or less) and S corporations typically don’t have to use the accrual method unless they have inventory.
• Lower risk of IRS audit exposure is desired, because S corporations file an informational tax return (Form 1120 S U.S. Income Tax Return for an S Corporation) and there is a higher audit rate for business income that is reported solely on Schedule C of Form 1040 (U.S. Individual Income Tax Return).

• Taxation. C corporations are separately taxable entities and file a corporate tax return, reporting profits or losses. Any profits are taxed at the corporate level, and losses don't pass through for use by the shareholders to offset other taxable income. The profits of C corporations face possible double taxation when corporate income is distributed to shareholders as dividends. First, the corporation pays tax on its corporate income; then, the shareholders pay personal income tax on the same income when it is distributed to them as dividends. S corporations, however, are pass-through tax entities so there is no tax paid at the corporate level. Profits and losses are passed-through the corporation and reported on the shareholders individual tax returns. Any tax due is then paid by the shareholders at their individual tax rates.
   
• Corporate ownership. C corporations can have an unlimited number of shareholders, while S corporations are restricted to no more than 100 shareholders. Also, C corporations can have non-US citizens/residents as shareholders, but S corporations cannot. S corporations cannot be owned by C corporations, other S corporations, LLCs, partnerships, or many trusts. C corporations are not subject to those same restrictions. S corporations can have only one class of stock (disregarding voting rights), while C corporations can have multiple classes.
   
• S corporation election. A corporation must elect to become an S corporation by making a timely filing of Form 2553 with the IRS, and all shareholders of the corporation must agree in writing to the S corporation election.

The limited liability company (LLC) offers an alternative to corporations and partnerships by combining the corporate advantage of limited liability protection with the partnership advantage of pass-through taxation. With this tax status, the LLC's income is not taxed at the entity level; however, the LLC typically completes a partnership return if the LLC has more than one owner. The LLC’s income or loss is passed through the LLC and reported on owners' individual tax returns. Tax is then paid at the individual level.
You form an LLC by filing incorporation (organizational) documents with a state and paying the related filing fees. LLCs also have fewer ongoing formalities and obligations than corporations.

Who should consider an LLC?

An LLC might be the right type of business for you if:

• Your startup company anticipates losses for at least two years and you want to be able to pass the losses through to yourself and the other owners.
• Flexibility for accounting methods is desired, because LLCs are not required to use the accrual method of accounting as C corporations typically are.
• Your business may own real estate.
• You want management flexibility, since LLCs offer more flexibility than corporations in terms of how the management of the business is structured.
• You wish to minimize ongoing formalities. Unlike corporations, which are required to hold annual meetings of directors and shareholders and keep detailed documents and records for all corporate meetings and major business decisions, LLCs do not face strict ongoing meeting and documentation requirements.
• You want flexibility for sharing profits among owners.

Most people opt to incorporate or form an LLC in the state in which their business operates. However, you are not required to do so; you can choose from any one of the 50 states or the District of Columbia (DC). You may want to consider which state is right for you to weigh any potential advantages or disadvantages. Remember, if you incorporate in a state other than the state where you operate your business, you may be required to register to transact business (foreign qualify) in the state where you operate, which results in paying registration and ongoing fees/taxes to both the state of incorporation and state of qualification.