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What are the benefits of incorporation?
The main reason to incorporate (or form an LLC) is to minimize your personal liability. Once your business is incorporated (either by forming an LLC or Corporation), it exists as a separate business entity. Essentially, you put a wall separating your personal assets from anything in the business. Of course, there are other benefits too. Here are the top reasons to incorporate:
- Minimize your personal liability and protect your personal assets
- Get more flexibility when it comes to taxes (talk to your CPA or tax advisor for specific advice on your personal situation)
- Boost the credibility of your small business
- Add a layer of privacy (don’t use your personal name and home address to represent your business)
- Start building your business credit
- Protect your business name and brand at the state level
What’s an LLC?
An LLC (Limited Liability Company) is a hybrid of a sole proprietorship/partnership and corporation. This structure is very popular among small businesses, and for good reason. The LLC limits the personal liability of the owners but doesn’t require much of the heavy formality and paperwork of the corporation. This makes it a great choice for business owners that want liability protection, but don’t want to deal with exhaustive meeting minutes, addendum filings, or other paperwork you’d need to file as a corporation. You can structure your LLC to be taxed as an S Corporation (as described above) where company profits flow through to the owners and are taxed at the personal income rate.
What are the drawbacks of incorporation?
The only real “drawback” of incorporating is that you’ll need to operate your business at a higher administrative level than you’re used to as a sole proprietorship. In addition, incorporating as a C Corporation can result in higher taxes for some small business scenarios due to double taxation. With a C Corporation, the business needs to pay taxes on any profits, and then owners are also taxed when any profits are distributed to them. Obviously, if you’re looking to put your small business profits into your own pocket, you may end up paying a lot in taxes. However, as the following question shows, there are ways to avoid double taxation, while still getting some of the benefits of incorporation.
When is the best time to incorporate?
In most cases, it’s best to incorporate or form an LLC as soon as possible. After all, the main benefit is liability protection and by waiting to incorporate, you can be exposing yourself to liability. Keep in mind that your corporation’s ‘start date’ is not retroactive. This typically means filing two business income tax returns for the year. For example, if your corporation was formed on June 1, you’ll need to file as a sole proprietor (or whatever your previous entity may have been) from Jan. 1- May 31 and then file as a Corp. from June 1-Dec. 31.