With the corporation being a popular business structure choice for small businesses, you might be considering forming one yourself. Still, you’ve got questions. Here we look at some of the most commonly asked questions, and provide the insight you need to make an informed decision about incorporating.
1. Why Would I Want to Incorporate?
The primary reason you would want to change your business structure from a sole proprietorship, which it is by default if you don’t choose another structure, is to reduce your personal liability. If you operated as a sole proprietor and were to be sued, your personal assets would be at risk.
On the other hand, if you form a corporation, you are a separate entity from your business, and your personal assets can never be touched to pay for business debt as long as you are in compliance with your jurisdiction’s incorporation laws.
2. What Are Some Examples of Why I Would Need a Corporation?
If you want to build your business credit separate from your personal credit, having a separate entity as a corporation is an excellent idea. Also, if you plan to seek funding from venture capitalists or angel investors, they will more than likely require you to have a corporation, because they don’t want their own assets to be at risk.
3. Are There Disadvantages to Forming a Corporation?
If you could call it a disadvantage, there is slightly more administrative paperwork than there is when you operate as a sole proprietor. Not only will you need to file your initial incorporation paperwork, but you will also be responsible for submitting an annual report and filing fee each year. It’s important to stay on top of this deadline so that you can keep your business compliant.
Also, C Corporations may end up paying higher taxes due to the double taxation situation. The C Corporation’s owners are taxed on their salaries, then the corporation itself is taxed on profit.
4. C Corp or S Corp? Which Is Right for Me?
Now more about the C Corporation vs. the S Corporation. The tax structure of the C Corp makes it less than ideal for many small businesses who can’t afford to pay twice for taxes on profits. The good news is that corporations can elect for S Corporation tax treatment, or “pass-through” taxation. Because an S Corporation doesn’t file its own taxes, profits and losses of the business are passed through and reported on the business owner’s personal tax return.
To qualify for S Corporation tax treatment, you’ll need to fill out Form 2553 with the IRS no more than 75 days from the date of incorporation, or no more than 75 days from the start of the current tax year. There are restrictions on which businesses can qualify as an S Corp. An S Corporation can only have 100 or fewer shareholders, and they must all be U.S. citizens or residents.
5. When Should I Incorporate?
Ideally, you incorporate before launching your business. If your business is already operating, the sooner you incorporate, the sooner you can protect your personal assets and your business.
Your corporation’s start date is not retroactive, which means that you’ll file two business income tax returns for the year: one for the part of the year before you incorporated, and one for the rest of the year as a corporation.
Many business owners prefer to set up their corporation paperwork so that it becomes effective January 1st of the new year to avoid having to file two tax returns.
6. How Do I Incorporate My Business?
There are three ways you can incorporate. Choose the one that best fits your needs, budget and time:
- Do it yourself: the most affordable, but most time-consuming. If you have more time than money and don’t mind reading legal documents, this is a good option.
- Online legal filing service: While you’ll pay a fee to have the filing service assist you, they will handle all of the paperwork and expedite the process. If you want your paperwork filed correctly and promptly, and don’t mind paying, consider this option.
- Lawyer: This is the most expensive option, but may be necessary in some situations. If you have complicated requirements for how your stock should be allocated, or you are working with millions of dollars, then you should hire a lawyer to help.
7. Where Should I Incorporate?
You may have heard that incorporating in Delaware, Wyoming or Nevada is a good idea, because these states market themselves as pro-small business and have low or no corporate income taxes. Still, that doesn’t mean they’re right for you. If your business will have fewer than five shareholders, you should incorporate in the state where you actually live or where you plan to operate your business.
When you incorporate in a different state from where you operate, you may have to pay additional fees and deal with extra paperwork in your home state, since you’re considered “operating out of state.” The extra hassle and fees just aren’t worth saving a little on your taxes.
8. What’s a Non-Profit Corporation?
If you operate a non-profit business—that is, one created for charitable, educational or other purposes—you should consider incorporating as a non-profit corporation. There are more rigid requirements by the IRS: non-profits can’t benefit the owners: all money above operating costs must be used to further the goals of the non-profit. In return, you can operate your non-profit tax-free.
To get these tax-free benefits, you have to be approved as having 501(c)(3) status by the IRS. A non-profit corporation operates similarly to other corporations or limited liability companies (LLCs), and creates a corporate shield that helps protect your personal assets and the assets of other stakeholders.
To learn more about LLCs, continue on to our next article and see if it makes sense for you business.