To Incorporate Or Not To Incorporate?
What factors you should consider when contemplating incorporation.
To Incorporate Or Not To Incorporate? Get all the information before you commit
By Paul A. Norman
Tax credits. Protecting your personal assets. Writing off a trip to Las Vegas so you can tell Wayne Newton "Danke schöen" in person.
If you own a business, you probably have been given all sorts of free advice regarding why you should incorporate.
Incorporating your business definitely provides several organizational and tax benefits — and can protect your personal assets from creditors if your business goes under. However, the process of incorporating your business involves a number of steps and potential missteps. Before you buy the company Ferrari with the intent of writing it off on this year’s return, there are a few important factors to consider when deciding whether to incorporate your business.
A Florida corporation is a legal entity that exists separately from its owners. But once you incorporate, you will face a host of administrative tasks and costs. You must establish and then follow bylaws, pay annual fees, file a separate tax return for the business, conduct annual meetings, submit annual reports to the state, retain a corporate bank account and maintain a system of accounting and recordkeeping. You can pay accountants, attorneys, consultants and extra employees to do these things for you. But that can get expensive fast.
Ask yourself if you’re ready for the paperwork and cost. Do you have the organizational skills and the tolerance to keep up with the obligations of the corporation?
Will the cost of incorporating exceed the benefit? Many business owners wait until they reach a level of profit that will cover the expenses of incorporation before they make the jump. Also, certain tax breaks or other benefits apply only to certain types of businesses. Incorporating your business can have a positive impact on your tax return, but it helps to know all the information before you commit.
Is a corporation the right type of business entity for your situation? It is essential that you consider all vehicles of organization for your business, such as partnerships and limited liability companies, as each entity carries a separate assortment of potential benefits and drawbacks. Discuss your options with an accountant and an attorney, who can help you make a decision based on your goals and needs.
In which state should you incorporate? You don’t have to incorporate in the state in which your business will operate. Many businesses are incorporated in Delaware or Nevada because those states have created corporate laws and tax structures that make it favorable for certain types of businesses. Of course, Florida officials would argue that they have also established a favorable environment for a growing business. Florida has no personal income tax and no minimum capital requirements for incorporating a business. Directors and officers of the corporation can all be the same person and Florida has comparatively low annual fees and lenient reporting requirements.
Remember that it often requires more money and paperwork to incorporate in one state and operate in another. But now that you know the option is out there, discuss it with an experienced business lawyer to make sure you get the absolute best setup for your situation.
Making the leap
Once you’ve decided that forming a corporation is the best option for you, what’s next? Call an experienced business lawyer to guide you through the process. Select a name for your corporation that has not already been taken. (You can search available names on the Division of Corporations Web site, sunbiz.org.) Among the other steps: filing articles of incorporation with the Division of Corporations; creating and adopting bylaws; obtaining a Federal Employee Identification (Tax I.D.) Number; designating officers, directors and a registered agent; issuing stock; and opening a corporate bank account. You’ll also have to get any applicable state and local licenses and pay all required fees.
Choosing a corporate form
You’ll need to make one more important decision: your type of corporation.
A C-corporation is a standard corporation. An S-corporation is a corporation that has elected special tax status under Subchapter S of Chapter 1 of the Internal Revenue Code.
When a C-corporation makes a profit, it pays federal corporate income tax on the profit. Many small businesses elect status as an S-corporation because income and losses are passed through to shareholders and included on their individual tax returns. If a C-corporation declares a dividend, the shareholders must report the dividend as personal income and pay tax on that income as well. S-corporations avoid this potential double taxation because all income or loss is reported only once on the personal tax returns of the shareholders.
Employee fringe benefits like health insurance may also be deducted by a C-corporation, but not by an S-corporation. In a C-corporation, profits beyond salaries and other deductible expenses can be used by the company for growth rather than being distributed to the shareholders.
Be aware that an S-corporation may have only a limited number of shareholders, and only certain individuals are eligible to be shareholders. An S-corporation may issue only one class of stock and faces limitations on the deductibility of its debt. Also, an S-corporation is subject to specific guidelines regarding certain tax deductions, employee retirement contributions and liquidation of assets upon dissolution.
The truth about liability
While incorporation can limit a creditor’s or judgment holder’s access to your personal assets, incorporation is not a get-out-of-jail-free card.
Directors, officers or stockholders of a corporation may be held liable for certain acts of a corporation if such an individual acts in a fraudulent or unjust manner, or when refusal to hold such an individual liable would deprive an innocent victim of redress for an injury caused by the representative of the corporation. Under certain circumstances, a court may consider a corporation the alter ego of its stockholders, directors or officers and "pierce the corporate veil" by determining that the corporation is merely a sham and holding the business owners personally liable. The general rule of thumb for minimizing the likelihood of personal liability is to operate your business as a corporation, i.e., follow all the requirements set forth by state law, keep your personal financial affairs separate from your those of your business, and don’t defraud anyone or do anything else illegal.
Remember too that incorporating a small business seldom protects the owners from liability should the corporation default on a loan or lease. Banks, lessors and other creditors often require personal guarantees on loans and leases, and if you make such a guarantee, chances are your corporation will not shield you from liability in the event of default.
Too often, small-business owners believe that limiting their personal liability for corporate debts and liabilities means they do not need much, or any, insurance. Accidents and errors will happen. Your employees might even commit negligent acts while on the job. Carry the appropriate type and amount of liability insurance, and if necessary, malpractice insurance. The typical guideline for selecting the appropriate amount of insurance is simple: buy the amount you can afford.
It is technically not necessary to use the services of an attorney to incorporate a business. Several helpful resources exist on the Internet and in your local bookstore. However, bear in mind that consulting an attorney allows you to benefit from the knowledge of someone familiar with the process.If you do your homework, ask questions and learn what is expected of you, it won’t be long before you see the benefits of You Inc.
This article is for general information only and should not be considered as legal advice or counsel. Such advice can be properly given only by qualified professionals who are fully aware of particular circumstances.