Starting a business can be a risky adventure. One way to limit your personal liability is by incorporating your business. While incorporation requires more paperwork than a sole proprietorship, it offers some important legal and tax advantages.
What Does it Mean to Be Incorporated?
Before we can talk about the benefits of incorporation, it is important to understand what it means. Quite simply, incorporation is the process of defining your business structure, both legally and strategically. A business becomes incorporated when the owner(s) file incorporation paperwork with the state. Often what is known as the Articles of Incorporation is filed which names individuals to serve as directors, identifies the business name and address of operations. When a business becomes incorporated it is recognized by state law and is viewed as a separate entity from an individual.
Benefits of Incorporation
Personal Asset Protection
As we alluded to above, when you incorporate a business you create an entity that is entirely separate from yourself. This is a great way to protect your personal assets. As a separate legal entity, a corporation can own property, conduct business, incur liabilities among other things. Most importantly, a corporation is responsible for its own debts. That means creditors of a corporation can seek payment only from the assets of the corporation and not from the personal assets of any shareholders, directors, or officers. This means you can conduct business without risking your home, car, savings, or any other personal property. Sole proprietorships or partnerships do not give business owners this sort of protection.
Credibility and Name Protection
A corporation is often perceived as being more stable than unincorporated businesses. In other words, adding “Inc.” or “LLC” after your business name can add a sense of legitimacy and authority that was not there before. Consumers, vendors, and partners often prefer to do business with an incorporated company.
Also, in most states, other businesses cannot form an entity or use a trade name that is the same as your corporate name. This helps protect your brand identity and offers some legal benefits.
Another major benefit to incorporated businesses is that it can continue to exist even if ownership or management changes. In fact, a corporation can continue indefinitely, despite what may happen to individual directors, officers, managers, or shareholders. Conversely, sole proprietorships and partnerships end if an owner dies or decides to leave the business. By incorporating your business, you may be able to avoid any future legal entanglements that often result with a changeover in other business structures.
Depending on how you choose to incorporate your business, there are many tax benefits available. Corporations are taxed on its profits. Those taxable profits can be reduced by qualified business expenses such as operating expenses, advertising expenses, travel expenses, and more. Incorporated businesses may also be able to deduct employee salaries, health benefits, contributions to retirement plans, and more. However, the taxation of corporations is complicated, and different structures have different tax advantages and disadvantages. It is best to meet with your tax advisor to discuss which corporate structure is best for your business.
Easier Access to Capital
At some point, your business will likely need to raise funds to grow your business or pay off debts. This task is usually easier for corporations as they can issue shares of stock. Banks also prefer to lend money to corporations than to sole proprietorships or partnerships. This makes getting a loan through your bank much easier than the alternative structures.
Incorporating your business comes with many important advantages. However, there are many options to consider. It is best to assess the tax implications of incorporating your business with your CPA or tax advisor before making a decision on which structure to go with.
We all know incorporating your California business has some great benefits. When the time comes to incorporate your business, every business owner must make the decision of which corporate structure to legally choose for the business. Filers are given the choice between forming an LLC, C Corp and S Corp, which each offer specific benefits and drawbacks, depending on the business in question.
When making the choice between these three entities, a number of factors must be considered. The main characteristics of each structure follow, along with detailed accompanying videos on these topics featuring the Cityline Tax team of experts.
First, here’s a short video that provides an overview of your options for choosing a business entity:
The Limited Liability Company (LLC)
Forming a Limited Liability Company (LLC) provides business owners with personal liability protection, just as one receives when doing business as a corporation. Similar to an S corporation (or S corp), business income and expenses are reported on the owner’s personal tax return, often on Schedule C of IRS Form 1040, which is also used by sole proprietors. Some reasons to choose an LLC for your corporate structure include:
- Your business owns real estate.
- You desire a flexible company management structure.
- You’re also seeking flexibility in what accounting methods are used.
- You want greater control of profit-sharing options among owners.
- You anticipate losses for at least two years and you want to pass the losses through to yourself and other owners (if any).
- You value a simplified, less formal structure, without mandates for annual shareholder and director meetings, and documentation of said meetings.
The S Corporation (S Corp)
As with an LLC, an S corporation’s profits, losses and other tax items pass through the corporation to the business owner and are reported on their personal tax return, so essentially the S corp does not pay tax. Good reasons to consider forming an S corp include:
- You’ll enjoy greater leeway for setting salaries for employees and owners in order to minimize Social Security and Medicare taxes.
- S corps may also employ flexible accounting methods, which typically don’t use the accrual method employed by C corps.
- You can take advantage of benefits of a corporation, as well as the pass-through taxation advantage of an LLC.
- S corps face lower risk of an IRS audit, since S corporations file an informational tax return (Form 1120 S). Audit rates are higher for business income reported solely on Schedule C of Form 1040.
The C Corporation (C Corp)
The most complex and demanding of the business structures, a C corporation (or C corp) is a separate taxpayer from the business owner(s). When corporate profits are distributed to owners in the form of dividends, owners must then pay personal income tax on the distribution, for “double taxation.” Still, there are some sound reasons you may want to operate as a C corp, including:
- The desire to finance the business through venture capital.
- Flexible profit-sharing options among owners.
- The structure helps keep company earnings within the business, aiding growth.
- For tax-planning, options are available for distributing business earnings between the corporation and shareholders.
- Owners can set salaries for employees and owners that minimize Social Security and Medicare taxes.
- The C corp can provide significant healthcare and medical benefits, as well as other benefit programs for education, life insurance, transportation costs and more.
- When you want to sell your business, it’s easier to do it as a C corp.
- C corps can offer stock options to employees.
- Your business will own real estate.
- You’ll lower your risk of an IRS audit, because audits are conducted more frequently when a Schedule C is filed for Form 1040.