incorporated

When Should You Consider Incorporating Your Small Business or Start-up?

Whenever the question of business incorporation comes up, many small and home-based business owners almost instinctively recoil.

I think their reaction has a few sources. Becoming a corporation is perceived as this leap of grandiose proportions in which they would somehow cease to be and operate as a small business. There is also the fact that the term “corporation” is associated with so much unpleasantness: greed, corruption, cubicle farms, downsizing, and off-shoring. Why associate your brand with such an entity?

The reality, however, is that incorporating your small business definitely has some big ramifications- not all of them so pleasant- but in many cases, it is a necessary part of running a business even if you never plan on selling stock.

So, the million dollar question is: when should a small or home-based business consider incorporation?

The Headaches of Incorporating Your Small Business

Before I go into some of the good reasons to take on a corporate form, lets take look at the real headaches first. It’s almost always easier to deal with a difficult thing when the hard parts are clearly spelled out.

That said, here they are:

The issue of payroll processing. As a sole proprietorship or within a standard partnership with one or more people and no employees, you don’t have to deal with employee payroll. When you incorporate you are obligated to do payroll processing even if you or you and your partner(s) are the only employees. Payroll processing costs time and money. You need to regularly prepare payroll checks and deposits. You also need to create quarterly payroll reports for Social Security, Medicare, state unemployment and workers compensation insurance, and you need to prepare annual payroll reports like W-2s for employees as well as the annual federal unemployment tax return. In some cases, you may also increase your payroll tax obligations.

The issue of complicated accounting and taxes. Incorporation means that the business requires more complicated tax accounting. A sole proprietorship reports its income and deductions within the owner’s individual tax return- a very simple one or two page Schedule C tax form. A corporation, on the other hand, requires a separate tax return for federal income tax and state income tax purposes. These returns can easily be ten to twenty pages long and will generally require the help of an accountant to complete and that typically does not come cheap.

The issue of state registrations and red-tape. Corporations equal paperwork- a lot of it. Consider that the states in which the corporation operates require annual re-registration. In addition, corporations usually require their shareholders, directors and officers to conduct regular meetings and to maintain detailed records of the items discussed at these meetings. All of this documentation- whether in physical form or electronic- requires time to complete as well as a system for storage and retrieval.

Why Would a Small Business Incorporate?

When small business owners go through the process of deciding how to register a company, it’s easy to focus on the wrong things. There is a tendency to put too much emphasis on short-term goals and on the tangible issues that come up in a business’ day-to-day operations. Business owners who incorporate are generally focused on the long-term health and sustainability of their company.

But, why should you incorporate in the first place- especially if you are not planning on selling stock in the company? The benefits typically fall into the following categories:

Protecting your personal assets. When your business is incorporated (as either a Corporation, S-Corporation or an LLC), it exists as a separate legal entity, which means the corporation (and not you) is held responsible for all of its debts and liabilities. What does this really mean? It means if you accidentally wipe out a client’s hard drive while providing some basic service, and that client wants to sue you, he or she can’t touch your house or your car, etc for reparation. Without incorporation, a dissatisfied customer or client would be able to sue you personally.

Corporate tax benefits. When it comes to the issue of corporate taxes, there are many potential benefits that can make it an attractive structure to operate under. Federal income tax rates are generally lower for corporations than for individuals, and corporations are typically entitled to additional deductions that are not available for sole proprietorships and partnerships. Moreover, if you incorporate your small business, you can determine when you personally receive income. So, instead of getting your income when it’s received, being incorporated allows you to take it at a time when you will pay less in taxes. Finally, incorporating your business gives you tax deferral potential. Because you can defer paying some tax until a later time, you may be able to realize tax savings if you are then in a lower tax bracket or if the tax rates have fallen.

Just an important side note here: You may have heard that the traditional C Corporation often results in higher overall tax payments through something known as double taxation. For this reason the LLC (limited liability company) and S Corporation are popular structures for small businesses since they avoid this issue of double taxation. With these business structures, the company is taxed like a sole proprietor or partnership, meaning the company itself doesn’t file its own taxes; all company profits are passed through and reported on the personal income tax return of the shareholders or, in the case of an LLC, the members.

Flexibility. As mentioned above, there are actually several different corporate business structures to choose from that run the gamut from the extremely formal C Corporation to the more flexible LLC. Choosing the right business structure is a multifaceted decision and will ultimately depend on all the details of your particular business needs, vision and circumstances- including funding sources, allocation of revenues, physical location, and the desired set up. But ultimately, if you are in need of personal asset protection and corporate tax breaks or you are in need of any other features of a corporation, then know that you have may a few options, and you don’t necessarily have to compromise on the current overall feel or set up of your business.

Just remember that you should really consult with a qualified accountant, tax adviser, or business lawyer to help you determine which business structure offers the biggest advantage for your situation. In the end, the right decision can really make the difference between the success or failure of your business, and that’s not something you want to recoil from.

Comments

  1. jimgladden says

    This is always a tough decision to make and can have a variety of tax implications. It is best to consult with a professional as to the pros and cons given your situation.

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