How and Why to Incorporate Your Business

Starting a small business can be as simple as having a place to work, either in an office or home, and spreading the word to your community. Once upon a time, that was the only option for the budding business owner. Business ownership has become considerably more complicated in the last hundred years and so understanding how to incorporate your business and the reasons to do it is a necessity.

Today’s business owner (that’s you!) is held personally responsible for the debts of a troubled business enterprise. The main reason for incorporating a business is avoiding personal liability for business indebtedness. Legally, a corporation is an entity with rights and privileges. To a corporation’s shareholders (you), it is a shield that prevents creditors from going after the shareholders’ personal bank accounts, homes and other personal property. If the corporation is sued, the corporation’s shareholders (you) are not personally liable for any judgement against the corporation – barring any fraudulent conduct by company officials (you), of course.

Taxation issues are another significant reason for incorporating a business. Corporations allow the owners to devise tax-free benefits including various types of insurance and retirement plans. Whether publicly traded or privately held, corporations issue stock. This simplifies transfer of ownership, as well as the raising of additional funds for the company. And because corporations are treated almost like a person under the law, they can enter into contracts, take ownership of real estate, and open other businesses if the shareholders so desire.

See more information on how to start a business in your state.

The Advantages of Delaware

Why are so many corporations created under the laws of the State of Delaware ? Since more than half of Fortune 500 companies are incorporated there, many people wonder what the attraction is. Simply stated, Delaware does not tax income earned in other states. Further, it has maintained a positive attitude toward business that is reflected in its laws. For example, if the owners of a business want to protect their privacy, Delaware requires less information about those owners than other states do. All of these advantages do not come without cost. Every state charges a fee for incorporating, ranging from $79 in Florida to $480 in Illinois. If you end up incorporating in Delaware and in your home state, you’ll pay a few hundred dollars more than if you just filed at home. Obviously some business owners feel that it’s worth it to spend the extra money. New business owners find it simpler and easier just to incorporate in their home states.

The Limited Liability Company

The Limited Liability Company is a fairly recent hybrid of corporate and partnership features, but it is not a corporation. As you would expect, the owners’ (your) personal liability is in fact limited except for any officer’s professional misconduct. The LLC offers the advantage of what is termed “pass-through” taxation. This means that the company’s profits are taxed only once, when profits are distributed to the owners (you) and reflected in their personal income tax returns. Owners forming an LLC must file what is usually termed a “certificate of formation” with the state. They also enter into an agreement similar to that of a partnership – this spells out just how the LLC will be run. Unlike corporations, LLC’s are not limited as to the number of shareholders they have who are not U.S. residents. Also unlike corporations, the Business Corporation Act of the state in which LLC’s are formed does not determine their business operations. That is strictly up to the owners. The usual corporate structure of officers and a board of directors do not bind them.

The Subchapter “S” Professional Corporation

The “S” Corporation is a favorite because, unlike the traditional corporation, it is taxed like a partnership. This means that taxes are only assessed when profits or losses are “passed through” to the individual owners of the business. This is an advantage that is shared with the LLC – neither one pays taxes on profits at the entity level. How do you form a Subchapter “S” corporation? Filing an IRS Form 2553 within 75 days of forming the business is all that is required in most states. A few states, including New York, require that a state form be filed, noting the election of the Subchapter “S” designation. Check with your state’s secretary of state or office on corporations to be certain that you’ve covered all the bases. The IRS provides all the required business at no cost.

The 501©(3) Nonprofit Corporation

The nonprofit corporation, under I.R.S. provisions, enjoys tax-exempt status, allowing it to fulfill its mission statement of serving the public without regard to revenues. Because donations are also tax-exempt, the nonprofit’s ability to attract donations is greatly enhanced. The Secretary of State of a state where incorporation is sought can provide necessary forms and crucial information on a particular state’s requirements. A caveat on nonprofit corporations: the name must contain the words “incorporated” or “corporation” or the obvious abbreviations of these. In addition, the name of the corporation must not suggest an affiliation with the federal government or a special entity such as “cooperative” or “trust.” The nonprofit organizers will also need to apply for an Employer I.D. number or EIN from the I.R.S. The IRS proper form is SS-4. As the state Attorney General is required to keep tabs on nonprofits, you may be required to register with their office as well.

As always, any uncertainties should be brought to the attention of an attorney specializing in business organization. After you’ve considered the pros and cons of the various business formats, make sure you’ve taken all the steps necessary to insure smooth sailing for your business as you go forward.

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