4 Reasons to Incorporate Your Business
Top 4 Reasons to Incorporate Your Business
Many individuals form a new business and are often in a rush to incorporate because of advice from friends and other advisors. This is usually a big mistake, and can be rather costly if the business doesn’t meet expectations, and closes.
Before you call your attorney to incorporate your business, you need to understand what the benefits are, and also the possible negative aspects. Besides, there are a few more types of business organization that you might want to consider.
My advice, and this won’t cost you anything, is to wait. Conduct the business as a sole proprietor for a while, and see if this is what you enjoy doing. Review the operations to see if it is profitable, or if it has the potential to be profitable in a certain period of time.
As an example, in my state the total cost to incorporate can be costly. If you use an attorney, his fee usually starts at $250.00 and up, depending on the complexity. Recording fees paid to the state are around $100.00, and then an annual corporate fee paid to the state for $300.00. You’ll find many other states that are much higher.
Getting financing is one reason to incorporate
There are some lenders that prefer your business to have a specific legal structure, rather that a sole proprietorship. Often, that is a point of perception on their part. They feel that you’re serious about making the business succeed, and that gives them some comfort.
It limits your personal liability
When you incorporate your business, it generally puts a shield between the business and your personal assets, thereby limiting your personal liability. However, this is not always true, and you must be aware of this.
The first exception is when you go to a lender with your new business to borrow money. Unless you or someone else pledges liquid collateral as security for the loan, the lender will insist that you personally guarantee the corporate loan.
If your business goes belly-up, and one of your creditors is owed a large amount of money, they will more than likely try to “pierce the corporate veil.” What that means is, they will look carefully at your business and try to prove to the court that your corporate status is a sham. Here are some, but not all of the issues:
- The owner of the business doesn’t really have a legal separation of business and personal affairs. Often times, the corporation is paying personal bills of the owner from its checking account.
- The owner might make an important business decision that affects the corporation and doesn’t record it in the minutes of a required meeting.
- The owner committed a fraudulent action such as borrowing money that he knew the corporation would not be able to pay. Or made business deals that were reckless or dis-honest.
- Co-mingling assets such as depositing a check payable to the corporation into the owner’s personal account.
- Not following the corporate requirements to maintain minutes, hold annual meetings, and other books and records such as adopting bylaws.
Tax reasons for incorporating
There are two types of corporations…a C Corporation and a S Corporation. The C Corporation is taxed on its profits at the corporate level. For many years, the tax was on a graduated method, with the starting tax rate at 15%. The Tax Cuts and Jobs Act which became effective for the tax year 2018, changed the corporate tax rate to a flat 21%.
An S Corporation is not normally taxed at the corporate level, and instead, passes on the profit or loss to the owner. This is then reported on the owner’s personal tax return who pays the tax. In the past, when the starting rate was 15%, it was often more economical to use a C Corporation structure when the owner’s personal tax rate was higher.
But now, with a flat 21% flat corporate rate, many individuals have personal tax rates below the 21% rate. There are other reasons, too, that you need to consider when you decide to incorporate your business. This is usually a good time to discuss it with your accountant or advisor.
Incorporate your business and manage income
As we mentioned earlier, don’t make a decision to incorporate your business when just starting out. Start as a sole proprietor to see if this is what you want to do with your life. Review the operations, too, to see if its profitable, or will be.
At that time, it might be a good idea to incorporate your business, either as a C Corporation or an S Corporation. You can then draw a salary, set up a retirement account, and other perks that will be available to you.
The bottom line is, don’t incorporate your business just because one of your friends or associates says you should. Every situation is different, and you need to discuss it with your accountant and/or financial advisor. Make the decision based on your facts, not some one else’s.