For years, Spencer has been working hard at building his surfboard business in Malibu, called Never Board. His small business sells surfboards, wetsuits, boogie boards, and beach apparel. His business has become a staple in the local community, and financially the company is doing well enough to support expansion. Spencer has also considering hiring surf instructors to teach local kids and tourist how to surf. However, he is naturally worried about liability. If something goes wrong and the business is held liable, Spencer does not want to take the brunt of a lawsuit. He would lose his livelihood and possessions in such a situation. He wonders how he can protect himself. His business partner Chad suggests that they incorporate the business, which would protect them from liability. It would also mean that they, as a corporation, would not have to pay such steep taxes. Chad also suggests that having “Inc.” attached to their name would add legitimacy to their brand, which would help them if they plan to go forward with expansion. Spencer is thus tempted to turn his small business, his brain baby, into a corporation.
7 Advantages of Incorporating
When it comes to incorporating, there can be benefits for companies large and small. There are many advantages for forming a corporation or limited liability company (LLC), including the following.
Protection of Personal Assets
Corporations and LLCS enable business owners to protect their personal assets by separating them from the business. This means that if a company is correctly structured and managed, a business owner should have limited liability for a business’ debts and obligations.
A company that has “Inc.” or “LLC” after its name may benefit from an added sense of authority or credentials. Customers and vendors may have a more positive response to companies seen as legitimate, bearing the mark of incorporation.
Corporations and LLCs are recognized in all fifty states and the District of Columbia.
Protection of a Business’ Name
Depending on the state, one’s business is protected from having its exact name used by another company in the same state.
Even if ownership or management changes, corporations and LLCs will continue to exist. Whereas sole proprietorships and partnerships end when an owner dies or leaves the company, a corporation or LLC lives perpetually. This is because in the United States, a corporation is considered to be similar to a person.
By electing Subchapter S tax status, a corporation can avoid double taxation of corporate profits and dividends. Similarly, an LLC can file to be taxed as a corporation.
Normal business expenses, such as salaries, can be deducted before designating income to owners of corporations or LLCs.
The Importance of Incorporating
Unlike sole proprietorships and general partnerships, corporations and LLCs can provide a business owner significant asset protection. Essentially, a sole proprietor or partner assumes unlimited liability, or responsibility, for his or her business’ debts and obligations. If something goes wrong for the business, such as a judgement being made against it, then the owner’s personal assets (home, car, savings) may be at risk.
Corporations are different in that they allow business owners to keep their personal assets separate from the business, thereby protecting them from potential judgements. An owner of a corporation or LLC does not need to worry about losing his or her car or home because of a legal problem their business is facing.
Location of Incorporation
Generally, businesses choose to incorporate in the state in which they are operating. So, a California company will incorporate in the state of California. This is because:
- It is less complicated to choose one’s home state
- Incorporating a company in another state is more expensive
- One can avoid paying franchise taxes and filing annual reports in more than one state
That said, it is common for corporations to do business throughout the United States and across the world. So, a corporation that has locations in multiple state can incorporate in one state, then register to do business in other states. But to conduct business in additional states, one must register, file annual reports, and pay annual fees.
Corporation vs. LLC
In order to protect their personal assets, most individuals choose to incorporate their business or turn it into a limited liability company (LLC). LLCs tend to be popular among small business owners because they have the best of both worlds: the simplicity of a corporation combined with the tax advantages of a partnership. An LLC can be owned by both individuals and businesses.
However, LLCs cannot issue shares of stock, while corporations can. Another benefit of corporations is that the IRS taxes corporations at a lower rate than individuals. When a business is incorporated, it also uses bylaws to structure its management, including shareholders, directors, and officers.
Above, we mentioned how corporations receive certain tax advantages. The nature of tax regulations really depends on the specific type of business one creates. Some of these regulations include:
- C corporations (also known as C corps) file a form 1120 to report corporate income to the IRS. The IRS will tax company profits at corporate tax rates. Meanwhile, dividends paid to shareholders will be taxed at individual rates. A C corp, therefore, is subject to double taxation.
- A corporation can apply to the IRS to obtain Subchapter S corporation status (S corp). This allows for “pass-through” taxation, which means that owners can report their share of company profit and loss on individual tax returns. However, an S corp cannot have more than 100 shareholders.
- An LLC has pass-through taxation, similar to a partnership or proprietorship. This means that double taxation is avoided, because the IRS does not assess taxes on the company.
How to Incorporate a Business
To incorporate a business, an owner should follow these steps:
1. Make the Decision to Incorporate
Before incorporating a business, an owner should review the advantages of forming a corporation or LLC and fully understand the process. Incorporation leads to a change in finances and administrative structure, so a business owner should be aware of these matters. Whether or not incorporation is the right move depends on the nature and goals of the company.
2. Select a Business Type
As we discussed above, there are different types of business structures, including C corps, S corps, and LLCs. All of these have different advantages for businesses, but much depends on the nature of the company and what its goals are.
3. Choose a State
Depending on a company’s goals or needs, it may choose to incorporate in its home state or another state better suited to it. States have different guidelines for incorporation, so it’s important that a company wishing to incorporate in another state receive advice on that specific process.
After incorporating their business, owners may wish to pursue the following steps:
- Apply for an employer identification number (EIN)
- Get business licenses and permits
- Create bylaws