How to Incorporate Your Small Business

There's more than one way to incorporate to your business, so before you hang out your shingle, you'll need to learn how to incorporate it and determine which type of incorporation meets your business size, operational needs and future goals.

Why Incorporate?
When you incorporate your business, it becomes a legal entity independent of you. The business, not you, is legally responsible for the debts and actions of the company. If the business amasses significant debt or there's a judgment made it against it in a lawsuit, your personal assets are protected. If you're in a line of business where lawsuits are common or an industry that carries a risk of running up significant debt, you should strongly consider incorporating your business.

If you choose not to incorporate your business, you'll operate as a sole proprietor. When it comes to legal and financial matters, there's no separation between your business and personal assets: You're personally liable for all the debts and actions of your company.

The benefits of sole proprietorships include lower startup costs (it costs money to incorporate your business and often requires the services of a lawyer), simpler tax returns and the ability to pay yourself without setting up a payroll account. One key disadvantage is that banks and investors may not take your business seriously if you need to raise capital later down the road.

Partnerships, both general and limited, are technically separate legal entities, but this separation usually applies only to the ability to sign contracts and borrow money. For tax purposes they function like sole proprietorships. General partners are jointly responsible for the debts and actions of the company; one partner can be held fully responsible for debts and actions of another partner. In a limited partnership, one person invests in the company without contributing to its operations in any way and liability is limited to the amount of that investment.

Limited Liability Companies
One of the most common ways to incorporate your business is to form a limited liability company. LLCs combine features of partnerships and full corporations but are neither corporations nor partnerships. An LLC may be formed with one or an unlimited number of members. LLC members may be individuals, corporations or other LLCs.

If you incorporate your business as an LLC, the main advantages are that members cannot be held responsible for the debts of the company; business income is passed through to the owners of the LLC and reported on the owners' personal income tax return; and the LLC is not required to hold meetings, take meeting minutes or record resolutions.

Small business corporations, or S-corporations, also offer owners limited personal liability and carry the tax advantage of passing business profits and losses through the owner's personal tax return. And if you sell your business, status as an S-corporation could reduce the amount of any taxable gains you earn.

The drawbacks to incorporating your business as an S-corp include tight regulations on the size of the S-corp (75 shareholders, maximum); being limited to distributing only one class of stock to those shareholders; and the legal requires to hold company meetings, take meeting minutes and report on them.

A C-corporation is the most complex way to incorporate a business. C-corporations are formed with the state government and required to adhere to the corporate laws in the state where it was incorporated.

The main advantages to forming a C-corporation are limited liability for the owners; more tax deductions, including your salary and your employees' salaries, benefit plans and depreciation; the ability to issue multiple classes of stock; and the shortest path to taking your company public.

The drawbacks of incorporating your business as a C-corporation point mainly to the overall complexity of the process and its continuance, and double taxation. Your startup costs to incorporate your business as a C-corporation may be significant, and the legal requirements for operation that you're bound to require ongoing administrative, legal and management resources. When the corporation shows profits, those profits are taxed at the corporate level and then taxed again at the shareholder level when they're issued as dividends. For large businesses, the overall benefits tend to outweigh the other burdens.

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The decision to incorporate a business is a smart one, and not difficult to do. Business incorporation confers many legal protections and tax advantages that are simply not available to a sole proprietor.

So... you've started your own business or organization and now you want to learn how to go about incorporating it. This guide is intended to show you just how to do it, even if it involves incorporating yourself or your family.

Frequently Asked Questions on
More Related Life123 Articles

An LLC, or "limited liability company," represents a business entity created by two parties, which means problems stemming from the business affect the business only and not the parties' personal assets.

What does LLP stand for, and how can it help your business? A limited liability partnership might be a good fit for your new enterprise because it protects partners from each other and helps cut down on taxes.

Which is better: LLC or LLP? Sometimes, a Limited Liability Company and a Limited Liability Partnership aren't all that different, but it depends on the state in which you start your business.

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