The Pros and Cons of Incorporating Your Company

The Pros and Cons of Incorporating Your Company

Nathalie Goldstein |Aug 13, 2019

What Is a Corporation?

When starting your own business, you will need to determine how you want to legally structure your company.

Sole Proprietor versus Corporation

When starting out, many businesses are sole proprietorships or partnerships, depending on the number of business owners. A sole proprietorship is a business that is owned by one person.

Starting a sole proprietorship is fairly easy. Most businesses in America fall under sole proprietorships.

This is where a corporation differs. Incorporating a business will require a lot of paperwork and consideration.

Advantages of Incorporation

Limited Liability

The main reason to incorporate is to protect the business owner's personal assets.

As a sole proprietor, you and your business are considered one and the same. If someone sues your business, your business and personal finances are at risk. You might have to use your own money and possibly sell your home to pay any business bills.

Registering your business will help separate yourself from the business' debts and financial obligations, hence providing you limited liability.

Ease of Ownership Transfer

Incorporating your business will make it easier to sell your business in the future.

A sole proprietorship will normally stay and die with its one shareholder. As its own legal entity, ownership of the business can easily be moved to someone else.

This flexibility will help you raise capital by selling interests (shares) of the company. Eventually, you could even sell the entire business to another party through an acquisition.

Some Tax Advantages

As a corporation, you can benefit from additional tax savings. Corporate tax benefits include:

  • Savings on self-employment taxes:Not all profit is subject to the U.S. self-employment tax (roughly 15.3%)
  • Lower corporation taxation rates (21%)

Disadvantages of Incorporation

Additional Administrative Work

Incorporating your business will require additional administrative overhead and effort.

The level of management required depends on the type of corporation you choose. At a minimum, registering a business will require:

  • Choosing which state to incorporate in
  • Filling out the required documents
  • Paying business registration and maintenance fees
  • Filing a business tax return annually

Double Taxation

As a larger corporation, you will most likely face double taxation on profits. Double taxation is when the same amount of money is taxed twice.

For example, C-Corporations will pay income tax as a company. Then you, as a business owner and shareholder, will most likely take out money to pay yourself. The income you receive from the company will then be taxed at your personal tax return.

This double taxation can be avoided by using a "pass-through entity." This means that profits will always be passed through the company and onto the shareholders. The company, therefore, will not pay any income tax.

Types of Corporations

Limited Liability Corporation (LLC)

What is it? An LLC is often used as the first legal structure a new business will form. It offers limited liability (protection of personal assets) as a separate legal structure from the business owners.

Pros: LLCs offer legal protection for owners and are often easier to set up and maintain. Tax-wise, the IRS is flexible with how an LLC is taxed. It can be set up as any of the following three categories:

  • A sole proprietorship: taxed at the individual level and subject to self-employment tax
  • S-Corp: taxed at the individual level and not subject to self-employment tax
  • C-Corp: taxed at the company and individual level

Cons: This legal structure can only be in place for a limited amount of time. Many states restrict the time limit to a maximum of 30 years.

LLCs are NOT corporations, therefore there is no stock ownership structure. A stock ownership structure is required to sell an interest in the company to future investors. This, therefore, makes it harder to raise capital or sell ownership.

S-Corporation (S-Corp)

What is it? An S-Corporation is not an actual business entity structure. It is a way to classify your corporation to the IRS.

Pros: Having an S-Corp helps lower the tax burden for business owners. With an S-Corp, income is passed through the company directly to its shareholders (owners) as salary and profits. This means no double taxation. Secondly, business owners with an S-Corp can avoid the 15.3% self-employment tax as well.

Cons: "S" stands for small and is, therefore, more fit for smaller companies. S-Corps have many restrictions including:

  • It must be a U.S. company
  • It cannot have non-U.S. citizen or resident owners
  • It cannot have more than 100 shareholders

More IRS restrictions can be found here.

C-Corporation (C-Corp)/Incorporated Companies (Inc.)

What is it?
A C-Corporation is essentially the next level up from an LLC, allowing stock ownership structure. Being incorporated (Inc.) refers to the C-Corporation Structure.

Pros: This legal structure is mainly for larger corporations, which can make your business look more credible. By allowing a stock ownership structure (which means you can give out shares of ownership of the company), you will have an easier time looking for investment.

Cons: Corporations require a stricter management structure. You will need:

  • A Board of Directors (directors of the company)
  • Corporate Officers (executive team such as a CEO)
  • Shareholders (owners of the company)

C-Corporations also have to pay corporate tax. Then when you take a salary payment, you will need to pay personal income tax on that amount too. This can be seen as double taxation.

Non-Profit Corporation

What is it? As the name suggests, a non-profit corporation is the opposite of a for-profit company. The goal of this company is not to earn profits for the shareholders (business owners). Rather, the company is looking to achieve another goal such as saving the environment.

Pros: Tax-exemption is the main benefit of incorporating as a non-profit, alongside the benefit of limited liability. If qualifying under IRS rules, the organization will not need to pay corporate tax.

Cons: The effort to create and maintain a non-profit organization is increased due to strict regulations such as the IRS Tax Code.

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Katie Macomb | August 13, 2019

It's Not Fun, but It Has to be Done Benjamin Franklin wrote a 1789 letter that states, “But in this world nothing can be said to be certain, except death and taxes.” Even at the United States’ early beginnings, federal taxes were a necessary evil to fund various public projects and administrative costs. Today, federal taxes serve much of the same purpose. While virtually no one likes to prepare and file their taxes, it is a necessity if you want to avoid fines and further hassle. It is no secret that preparing and filing your taxes is notoriously complicated. Many people lament that it should not be so difficult to pay the government. However, some of the complications allow people to save money if they discover specific tax benefits. Knowing how to file your own taxes may be a good option if your tax situation is relatively straightforward, or if you are willing to learn the process. Why Do You Need to File Your Taxes Every Year? The short answer is that federal law requires that most individuals file taxes annually. Income taxes are assessed every year based on your income earned during that period. You then pay a percentage of that income to the government, less any deductions, adjustments, or credits that you qualify to receive. If you do not file (and pay) your taxes, then you may be assessed penalties and interest. The Internal Revenue Service (IRS) can even go as far as garnishing your wages and repossessing your property if you do not file and pay as required. The Benefits of Filing Your Own Taxes If you are one of the 43% of Americans that are doing your own taxes, you are certainly not alone. Roughly 53 million people prepared and filed their own taxes in 2018. There are many benefits to filing your own taxes, including: Saving money: Hiring a tax professional is expensive, and many people can prepare and file their returns on their own, completely free of charge. Control: Some people like knowing the exact information that is included in their return and being able to control the data, and for some, knowing precisely how the numbers work out, is comforting. Gain helpful information: When you prepare your taxes, you can see what items saved you money this year or which issues you should address so you can save money next year. While filing your own taxes is complicated, it can be beneficial under the right circumstances. There are several programs online that walk you through the process to help ensure you are taking advantage of all of your available deductions and credits. The Drawbacks of Filing Your Own Taxes In addition to the benefits, there are also some disadvantages to filing your own taxes. These include: Time and effort: Preparing and filing your taxes takes time and work You have to sift through financial information and deal with concepts that you may not understand well. The process can be frustrating and take a considerable amount of time. Error risk: If you do not completely understand how your taxes work, you run the risk of making a mistake because of misconceptions. If that happens, it could lead to underpayment and audits down the road. Questions: Even if you use a tax preparation software, you may still have questions that will remain unanswered unless you do significant research or reach out to a tax professional. For some people, the risk of having a substantial error that triggers the IRS’s attention is enough to scare them away from preparing their own taxes. Preparing for Filing Your Taxes When you begin work on your taxes, you should have information gathered throughout the year. 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