Incorporation is an important step in the life of a business, but unfortunately the true value of incorporating a business is often not seen until the business faces a negative situation such as a law suit or bankruptcy.
Why Incorporate Your Business
A primary advantage of incorporation is the limited liability the corporate entity affords its shareholders (owners). Typically, shareholders are not liable for the debts and obligations of the corporation; thus, creditors will not come knocking at the door of a shareholder to pay debts of the corporation. In a partnership or sole proprietorship the owner’s personal assets may be used to pay debts of the business.
Other Advantages of Incorporation
- A corporation’s life is not dependent upon its members. A corporation possesses the feature of unlimited life. If an owner dies or wishes to sell their interest the corporation will continue to exist and do business.
- Retirement funds and qualified retirement plans (like 401k) may be set up more easily with a corporation.
- Ownership of a corporation is easily transferable.
- Capital can be raised more easily through the sale of stock.
- A corporation possesses centralized management.
Corporations are not without disadvantages. The primary disadvantage to a corporation is double taxation. Profits of a corporation are taxed twice when the profits are distributed to shareholders as dividends. They are taxed first as income to the corporation, then as income to the shareholder. All reasonable business expenses such as salaries are deductions against corporate income and can minimize the double tax. Further, the double tax can be eliminated by making the S corporation election with the Internal Revenue Service.
Other Disadvantages of Incorporation
- There is a certain level of complexity and expense of forming a corporation.
- Corporations have extensive record keeping requirements.
- Operating a corporation across state lines requires the corporation to qualify to do business in the other state.
Both the Limited Liability Company (LLC) and S corporation also provide the limited liability to the owners/shareholders of the company, without the potential disadvantage of double taxation. While like corporations these two entities also have advantages and disadvantages, it is a good idea to learn about all three when deciding what form your business should take.
Where to Incorporate Your Business
One of the first decisions a business must make after deciding to incorporate involves selecting the proper state of incorporation. You are 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.
In making the decision of where to incorporate, three factors typically are weighed:
- the location of your physical facilities,
- a cost analysis comparing incorporating in the state of operation versus qualifying to do business as a “foreign corporation” in the state under consideration and
- determining the advantages and disadvantages of each state’s corporate laws.
When analyzing these three factors, keep in mind that a corporation is referred to as a foreign corporation in all states except for the state where it is incorporated. If a corporation is transacting business in a state other than the state where it is incorporated, it must register for a certificate of authority to transact business in the other state or possibly lose access to that state’s courts and face fines.
The decision of where to incorporate is typically between the state of operations and Delaware. If the corporation is a “closely held” corporation that does business primarily within a single state, local incorporation is typically the best decision. Closely held corporations are corporations that possesses the following traits: a small number of shareholders, no ready market for the corporation’s stock and substantial participation by the majority shareholders in the management of the corporation. For corporations doing business in a single state, the cost of local incorporation will usually be less than incorporating in another state and qualifying to do business as a foreign corporation in that state.
A foreign corporation that qualifies to do business in another state is subject to taxes and annual report fees from both the state of incorporation and the qualifying state. Thus, the actual advantage of incorporating in a state with very low or no corporate income tax is not as great as it appears, if your business must still qualify to do business in its state of operations.
Recommended Books in Incorporating Your Business:
- Incorporate Your Business: A Legal Guide to Forming a Corporation in Your State
- Inc Yourself, 10th Edition (Inc. Yourself: How to Profit by Setting Up Your Own Corporation)
- Incorporate! : An Easy Step-By-Step Plan for Entrepreneurs
- Incorporating Your Business For Dummies
Article provided by BizFilings, Inc http://www.bizfilings.com
Category: Business Structure