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If you are in business for yourself -as an individual working as a self-employed person- or are a business owner that also employs others, at some point or another you will likely come across the option of making your business incorporated. There are many different ways to structure a business. You can, for example, use legal classifications such as the S-Corporation, C- Corporation, or Limited Liability Corporation (LLC), or (depending upon which one you choose) you’ll be obligated to follow certain rules and regulations regarding such things like taxes.
Incorporating your business can entitle you to special tax perks and add protection to your business name so others cannot use it without permission. Being incorporated also lends stability and credibility to your company, brand and image. Once you are incorporated, for instance, even if the people who are running the business leave or die, the company can continue to exist under the same name with other people at the helm; which won’t work if you are a sole proprietor. Additionally, you may enjoy protection from having your personal assets seized during a business bankruptcy or having them threatened if somebody sues your business.
According to SBA.gov, more than 70 percent of United States businesses are run by sole proprietors. Part of the reason business owners may never incorporate is because they don’t feel they need the benefits that come from incorporating. Let’s have a look at some of the most popular ways to structure a corporation, so that you can decide for yourself whether it will be wise financial move for you.
Limited Liability Corporations
What if you own a business that goes bankrupt or winds up with terrible credit? Will that ruin your personal credit, too, and make it impossible for you to get a loan or a credit card? Perhaps it could. A corporate “shield” could save you, which is why forming an LLC is one of the most common and useful ways to incorporate. As the name implies, personal liability or exposure to things like bad credit or a lawsuit is limited if you run an LLC. If you only have a Sole Proprietorship, on the other hand, your personal credit and assets will be 100% exposed because the law and taxing authorities will not treat your business separately from your personal affairs.
A C-Corporation is a business that is viewed as a totally separate entity for tax purposes. Most of the major businesses in America are based on this unique legal framework. When you incorporate your business with this particular kind of structure, the business you own will be taxed independently from you. There are some advantages to incorporating your business in relation to taxes, and in terms of legal liability and asset protection. Special responsibilities also come with C-Corp status, though, and one of the obvious ones is that you have to file two sets of tax returns every year – one for your company and one for your personal income.
With an S-Corp, things work a little differently because your business does not have to pay separate taxes to the IRS. You file one personal return that simultaneously covers the business. Should you rack up losses during the business year you’ll be able to calculate those along with your personal income when you fill out your returns, which could save you a lot in tax dollars. Meanwhile, if your business has a prosperous year, your personal taxes will then be higher, but that will likely be balanced-out or offset by the profits from your business. The real distinguishing characteristic that inspires business owners to apply for S-Corp status is they don’t have to pay taxes twice (as a business and again as an individual taxpayer).
Other Unique Corporate Arrangements
- What if you would like to combine the protection of an LLC with the tax simplicity of an S-Corporation? There is actually a way to do that if you can have an attorney file the proper documents to request your LLC to be taxed as an S-Corp.
- If you’re incorporated in your home state you may also be able to get some valuable tax perks by going out of state to set up offices or satellite locations. Oftentimes the government wants to encourage this kind of interstate commerce in order to strengthen the economy and spread the success of a business to other regions.
- A friend of mine, for example, was incorporated in Texas, but experimented with running a branch office in Florida for a year. The venture was a big success and the Florida market brought in revenues of more than $150,000. At tax time, however, his CPA informed him that he didn’t owe any money on that revenue because of all the business deductions he was entitled to use as a company doing business in another state for the purpose of “market research and development.”
Cost and Complications
Forming a corporation and keeping track of the tax responsibilities, revenues, and other legalities may require some help from professionals, such as an attorney and/or CPA. For starters, you’ll need a corporate charter, filed with the Secretary of State, to complete the incorporation process. Having a lawyer draw that up is a good idea, but can be an added expense. If that charter expires or is revoked for any reason, you cannot continue to legally operate as a corporation, so you may want to have an attorney monitor that kind of timing on your behalf. As the owner of a C-Corp, you’ll be required to hold regularly scheduled meetings of the officers of the company and formally document those – even if the officers happen to be family members or friends. You may want to have a lawyer review all documents and you will likely benefit from the insight and expertise of a CPA to help you take full advantage of the legal tax benefits available.
More to Come
Stay tuned for my next blog later this week, where I will talk about ways for business owners to manage their personal and business money, credit, and assets. I’ll answer questions on topics like what happens to your business assets if you declare personal bankruptcy or what kind of personal and/or business credit banks expect to see if you apply for a business credit card versus a personal one.