It is true that operating as a corporation has its share of drawbacks in certain situations. For example, as a business owner, you would be responsible for additional record keeping requirements and administrative details. More important, in some cases, operating as a corporation can create an additional tax burden. This is the last thing a business owner needs, especially in the early stages of operation.
You do not have to incorporate to be in business. You can be in business just by being paid for a service or a product. You are then a sole proprietor as well as a self-employed freelancer. But there are certain pros that you and your business can benefit from incorporating.
Founders of startup companies often wait to incorporate a company until they are confident that their concept is viable or fundable. At some point, however, an entrepreneur will need to formally incorporate a company.
Aside from tax reasons, the most common motivation for incurring the cost of setting up a corporation is the recognition that the shareholder is not legally liable for the actions of the corporation. This is because the corporation has its own separate existence wholly apart from those who run it. However, there are four other reasons why the corporation proves to be an attractive vehicle for carrying on a business.
Owners of a corporation may only be liable for business losses and obligations up to their investment in the company. As explained on the Entrepreneur website, the shareholder’s personal assets may not be taken to cover the liabilities of the corporation. However, shareholders of an incorporated business may be liable for the company’s debts if they sign a personal guarantee on a corporate loan. In addition, shareholders that engage in criminal activities will be individually held responsible for their acts.
If you’re a sole proprietor, your personal assets, such as your house and car can be seized to pay the debts of your business; as a shareholder in a corporation, you can’t be held responsible for the debts of the corporation unless you’ve given a personal guarantee.
On the other hand, a corporation has the same rights as an individual; a corporation can own property, carry on business, incur liabilities and sue or be sued.
Incorporating a business can seem like a good idea, but the process and requirements of incorporation can actually hinder an organization’s growth and success, especially for smaller start-up companies. Incorporating a business provides some benefits, but the corporation definitely pays the price for these benefits in fees and legal hurdles. The main reasons not to incorporate include a sizeable initial investment, tax disadvantages, increased complexity in bookkeeping and public disclosure mandates.
To start the process of incorporating, you can contact your attorney or CPA. If you wish to do it yourself then contact the secretary of state or the state office that is responsible for registering corporations in your state. Ask for instructions, forms and fee schedules on business incorporation. It is possible to file for incorporation without the help of an attorney by using books and software to guide you along. Your expense will be the cost of these resources, the filing fees, and other costs associated with incorporating in your state.
If you do file for incorporation yourself, you’ll save the expense of using a lawyer, which can cost from $500 to $1,000. The disadvantage of going this route is that the process may take you some time to accomplish. There’s also a chance you could miss some small but important detail in your state’s law. You may also choose to use an incorporation service company to prepare and file the documents with the state.
One of the first steps you must take in the incorporation process is to prepare a certificate or articles of incorporation. Some states will provide you with a printed form for this, which either you or your attorney can complete. The information requested includes the proposed name of the corporation, the purpose of the corporation, the names and addresses of the parties incorporating, and the location of the principal office of the corporation.
You’re not required to incorporate in the state where your business operates; you can choose from any one of the 50 states or the District of Columbia.
Note that simply transacting business via mail order or the Internet typically does not an equal transacting business; however, the determination is made on a case-by-case basis. Again, consult your attorney for specifics, as this list is not intended to be comprehensive.
The corporation will also need a set of bylaws that describe in greater detail than the articles how the corporation will run, including the responsibilities of the shareholders, directors, and officers; when stockholder meetings will be held; and other details important to running the company. Once your articles of incorporation are accepted, the secretary of state’s office will send you a certificate of incorporation.
Once you’re incorporated, be sure to follow the rules of incorporation. If you don’t, a court can pierce the corporate veil and hold you and the other owners personally liable for the business’s debts.
To make sure your corporation stays on the right side of the law, practice these exercises:
Get Documents and Records in Order
After incorporating a business, you’ll need to prepare bylaws that describe how your new corporation will operate. A few states also require you to publish a newspaper notice of your incorporation.
You should set up a corporate minute book and a file or binder where you will keep important corporate documents such as your certificate of incorporation, bylaws, shareholder information, and resolutions. Some states require you to file an initial report after incorporation and you will generally need to hold shareholder and director meetings at least once a year.
An employer identification number, or EIN, is a number that the Internal Revenue Service uses to identify businesses—sort of like the business version of a Social Security number. Most businesses need an EIN, though solo business owners who don’t have employees or pay excise taxes can use their Social Security Number instead.
A business bank account will help you keep your business finances separate from your personal finances. This makes record-keeping and tax preparation easier and helps preserve your business’s separate identity.
For most businesses, the question is not if, but when, to incorporate. There are many pros and cons of incorporating a small business, depending a lot on individual situations. But too many businesses fail to revisit the question of whether to incorporate. As your business matures, and the realities of your legal and tax situations change, asking the question again may bring a different answer. A business with anticipated losses and little legal risk can likely start as a sole proprietorship, but increasing risk and more significant earnings will favor incorporating later on.
Deciding whether or not to incorporate is much more than just understanding the disadvantages of incorporation; the decision also requires knowledge about the advantages and disadvantages of other legal business formation options, such as sole proprietorships, partnerships, and limited liability companies.
You should definitely discuss your personal situation with your accountant and lawyer before you decide. He or she will be able to give you a much more exact picture of how incorporation could benefit your business, and help you see whether or not the trouble and expense of incorporation will be worth it to you.