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Financial Pros and Cons of Incorporating Your Business

Financial Pros and Cons of Incorporating Your Business

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If you are in business for yourself, at some point you may want to consider incorporating it, but what’s the best way to do it?

According to the Small Business Administration (SBA), the majority of nonemployer establishments are sole proprietorships (86.4%), while only 14.1% of establishments at small employer firms are sole proprietorships. There are 30.2 million small businesses in the country as of August 2018, it added.

Three of the most popular ways to structure a business are the S Corporation, C Corporation and the limited liability corporation (LLC). Depending on which one you choose, you’ll be obligated to follow myriad rules and regulations. But incorporating your business also gives you special tax perks and protection of your company name so others cannot use it without permission.

 

Business Structure

Ownership Liability

Taxes

Limited liability company (LLC) 1 or more people Owners not personally liable Self-employment tax; personal tax or corporate tax
S Corp 1 or more people, but no more than 100; all must be U.S. citizens Owners not personally liable Personal tax
C Corp 1 or more people Owners not personally liable Corporate tax

 

Being incorporated also lends stability and credibility to your company. Once you’re 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 others at the helm. Plus, you’ll be protected from having your personal assets seized during a bankruptcy or having them threatened if somebody sues your business.

Part of the reason business owners may never incorporate is because they don’t feel they need the benefits that come from incorporating. We’ll take a look at three popular ways to structure a corporation so you can decide if incorporation is the best move for you. We’ll also give you the information you need to help you choose the best way to incorporate your business.

Limited Liability Corporations

With an LLC, profits and losses can get passed through to your personal income without facing corporate taxes. But be warned — LLC members are considered self-employed and must pay self-employment tax contributions towards Medicare and Social Security. When it comes to federal taxes, the IRS considers LLCs a pass-through entity, where members report profits and losses on their personal tax returns, although some states impose an annual tax on LLCs.

Having an LLC protects you from personal liability, in most instances, and your personal assets — vehicles, houses and savings accounts, for example — won’t be at risk in case your LLC faces bankruptcy or lawsuits.

Some states limit the life of LLCs: When members join or leave an LLC, per some states’ legislation, the LLC may have to be dissolved and re-formed with new membership, unless there’s already an agreement in place for buying, selling or transferring ownership.

Medium- or higher-risk businesses, owners with significant personal assets they want to protect and owners who want to pay a lower tax rate than they would with a corporation are the best candidates for LLCs.

C Corporations

A C corp is a legal entity that’s separate from its owners. It can make a profit, be taxed and be held legally liable. This option offers the strongest protection to its owners from personal liability, but it costs more to form it. Additionally, understand that corporations also require more extensive record-keeping, operational processes and reporting.

Corporations pay income tax on their profits, which can be taxed twice — first, when the company makes a profit, then again when dividends are paid to shareholders on their personal tax returns.

If a shareholder leaves the company or sells his or her shares, the C corp can continue doing business. Corporations also have an advantage when it comes to raising capital, because they can sell stock.

Owners of C corps are required to hold regularly scheduled board meetings and formally document them, even if the officers are family members or friends. Consider hiring a lawyer to review all documents and a CPA who can help you take full advantage of the legal tax benefits available.

This option is good for medium- or higher-risk businesses, businesses that need to raise money and businesses that plan to go public or eventually be sold.

S Corporations

An S corp is a special type of corporation that’s designed to avoid the C corp’s double taxation. S corp businesses allow profits, and some losses, to be passed through to their owners’ personal income, but not being subject to corporate tax rates.

Note that not all states tax S corps equally — some tax on profits above a specified limit, while others don’t recognize the S corp election at all and simply treat the business as a C corp. You must file with the IRS to get S corp status.

As with C corps, strict filing and operational processes must be followed with an S corp. And much like C corps, if a shareholder leaves the company or sells their shares, the S corp can still continue doing business.

If your business profits are greater than your reasonable salary, S corp taxation may save you money. Consider also that your tax return will be somewhat more complex and, if you don’t have other employees, you will have to set up tax withholding. S corps are best for businesses that could otherwise be a C corp, but also meet the criteria to file as an S corp.

The bottom line

Now that you know the pros and cons on incorporating your business, you can decide which option is best for you. Whatever structure you decide, it’s important to consider hiring professionals, such as a lawyer or a certified public accountant, to track things like taxes, revenues and deductions, so you can be on solid footing — the last thing you want is to face a large tax bill from your state or the IRS.

Choosing the right business structure can be the difference between your business failing or succeeding. Each way of incorporating has its pros and cons, so take the time to analyze which one is best for your business.

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