At some point or another, you may decide to incorporate your company. Like many things in business, incorporation has its advantages and disadvantages. Read on to learn the pros and cons of incorporating a business to determine if it’s a good fit for your company.
Overview of incorporation
Before you dive into the pros and cons of incorporation, you have to know what incorporation is. Incorporation is the formation of a corporation, or C Corp. Small businesses may start out as a sole proprietorship or partnership and incorporate later on.
The main thing that separates a corporation from other types of business structures is the fact that a corporation is a separate legal entity from its owners.
To incorporate your business, you must follow state laws. Each state sets its own laws and has corporate tax rates you need to familiarize yourself with.
Incorporation pros and cons
Before you decide to incorporate your business, weigh your pros and cons. Check out the advantages and disadvantages of incorporation below to make an informed decision.
Advantages of incorporation
Take a look at some pros of incorporating your small business.
One perk of incorporating your business is limited liability. Some business structures, like sole proprietorships, must assume all the liability of the company. When you incorporate, owners or shareholders are not personally liable for the business’s actions and debts. Any claims against the corporation are not the owner’s responsibility, preventing the owners’ personal finances from being affected. It can protect owners from things like lawsuits, debt, and financial losses.
In short, limited liability helps shield the corporation’s owners from any personal liability.
Another pro of incorporation is continuance. Unlike other structures, a corporation has an unlimited lifespan. It continues to live on even if the shareholders leave the business or pass away. And, it still exists even if the ownership of the business changes. This makes it more likely that a corporation will thrive for many years, even if things change within the corporation.
Incorporating your business allows you to be a little more flexible when it comes to distributing income. When you incorporate your business, you can determine how and when you receive income.
Rather than taking a salary from the corporation when the business receives income right away, you can take income at a later time. You can also receive income in the form of dividends, which can help lower your tax bill.
Disadvantages of incorporation
Find out what kinds of disadvantages come with incorporating your business.
One downside of incorporating your business is the expense that comes with it. Because corporations are more complex than other structures, they tend to be more expensive to set up than other business structures.
To form a corporation, you have to pay fees. And after you establish your corporation, these fees don’t disappear. Fees for corporations are ongoing and can be costly for small businesses. Here’s an overview of the kinds of fees you may have to pay if you want to establish a corporation:
- Setup costs
- Legal expenses
- Accounting expenses
- State fees (e.g., filing with the state)
Many states impose ongoing fees on corporations. Check with your state to find out information about fees they charge corporations. And, ask yourself the question, Will I be able to afford the ongoing fees associated with incorporating my business?
Another disadvantage of incorporating your business is double taxation. Double taxation is when you have to pay income taxes twice on the same income. For a corporation, this means you’re taxed on both the personal and business levels.
Corporations pay taxes on their annual earnings. When a corporation pays out dividends to shareholders, the dividends have tax liabilities, too. Shareholders who receive any dividends must pay taxes on them.
Other types of structures, like LLCs or S Corps, can avoid double taxation with pass-through taxation. Pass-through taxation is when the taxes pass through the business and onto the owners or individuals.
If you want to avoid double taxation altogether, you may want to establish an S corporation or not incorporate your business.
Incorporating your business can be a time-consuming process due to all of the paperwork involved. To maintain a corporation, you must keep detailed records of your articles of incorporation and bylaws, including information about meetings as well as a register of directors, members, officers, and shareholders.
In addition to tracking meetings and other activities, keep organized records of transactions. You need up-to-date records of financial transactions so the corporation can file income tax returns.
Each state also has its own guidelines about recordkeeping requirements for incorporated businesses. Follow your state’s regulations to remain in good standing with the state and law.
Questions to ask yourself before incorporating
As you can tell, there are a number of advantages and disadvantages of incorporating your business. Before you make a decision of whether or not to incorporate, ask yourself the following questions to ensure it will be worth it in the long-run:
- Will I be able to afford the fees associated with incorporating?
- Can I keep up with the additional paperwork?
- Do I have the ability to keep accurate records?
- How will double taxation impact my corporation?
- Do the pros outweigh the cons?
Regardless of if your business is a corporation or not, you need an easy way to track your business’s income and expenses. Patriot’s accounting software lets you streamline your books so you can get back to your business. Try it for free today!
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This article has been updated from its original publication date of August 18, 2015.
This is not intended as legal advice; for more information, please click here.