Forming a Business Structure – Is Incorporation Right for You?

Credit Union Lending: A Solution to Small-Business Capital Crunch?Business incorporation has become synonymous with responsible business ownership. Yet, so many misconceptions and rumors exist about the benefits of business incorporation. So it’s no wonder that even the savviest entrepreneurs are at a loss as to whether incorporation is right for them, what it will cost, and where to start.

Business incorporation (which, by the way, is an umbrella term for a number of business structure options) may be right for some business owners, but it isn’t for all. So it’s worth doing some stepping back and ascertaining whether incorporation is right for you.

Here are some points to consider:

What is Business Incorporation?

As mentioned above, business incorporation is a loose umbrella term that covers a variety of options for legally structuring your business.  These options include becoming a limited liability company (LLC), corporation, S-corporation, non-profit 501(c)(3), cooperative, and so on.

Whatever business structure you choose needn’t be set in stone, and can be changed as your business matures. For example, many small business owners start out as sole proprietorships or partnerships with formal incorporation taking place at a later date.

Of the many business entities that owners consider, LLCs and Subchapter S Corporations (S-Corps) are two of the most popular. Read “Should My Company be an LLC, an S-Corp or Both? to determine which features are most important to you and your company.

The Benefits of Incorporation

Here are some of the benefits you can realize if you decide to incorporate your business:

  • Personal Liability Protection – An incorporated company affords protection from any personal liability for your business debts and obligations. For example, if someone sues your company they can only go after your company’s assets, not your own (although there are exceptions – see below**under “The Disadvantages of Incorporation”).
  • Tax Benefits – If you incorporate you may gain tax benefits, although only under certain circumstances. This is one area to discuss with an accountant, as the marginal tax rates for corporations with taxable incomes in some cases can be higher than those for an individual in the same scale. Read more about the tax implications of incorporating from the government here.
  • Corporate Identity – Incorporating can give a greater sense of credibility to your business.
  • Raising Capital – You can raise capital more easily through the sale of stock and securities if your business is incorporated.
  • Unlimited Life – Your corporation can have an indefinite life and outlive you. Do note that LLCs have a limited duration. Get more information on business structure differences from the SBA.

The Disadvantages of Incorporation

Some of the disadvantages of incorporation, particularly for the small business owner, include:

  • Paperwork - Depending on the structure you choose, you may need to file two tax returns (one for you, one for your business) and keep good records.
  • Cost - The fees associated with initial incorporation and ongoing maintenance can put a strain on start-ups. However, LLCs (a hybrid-type of legal structure that provides the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership ) can be a more economic alternative to incorporation.
  • **Liability may not be as limited as you think – The limited liability advantages of incorporation can be challenged by personal guarantees and credit agreements. For example, when a corporation has insufficient assets to secure a loan, banks often insist on personal guarantees from the business owner. This can result in personal liability for repayments if your corporation can’t meet its obligations.

Is Incorporation Right for My Business?

At the end of the day, choosing the right business structure for your small business comes down to several factors such as your risk of liability, your tax obligations, business objectives, and so on.

Because the needs of every business are different, and the law varies from state-to-state, it’s worth an hour or two with a knowledgeable attorney to investigate all of the issues that will affect your decision.

Getting Started with the Process of Incorporation

All business incorporations must be filed with your state government. Whether you choose to pursue this through an attorney or choose an online legal service is up to you. But try to get referrals and recommendations from other businesses that have been through the process.

If you operate in multiple states, read “Which State is best for My Small Business?” to determine which state is the friendliest to corporations and incorporate in that state.

Additional Resources

Business.gov Incorporation Guide – This Web guide draws information from across government to provide small business owners with vital information and resources about what incorporation is and how it can work for your business.

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Business.gov Business.gov is sponsored by the U.S. Small Business Administration to provide small business owners with access to federal, state and local government resources from a single access point. The Business.gov Community is an interactive extension of the site, creating a forum for business owners to interact with government, industry experts and each other through discussion boards, idea exchanges and blogs.

9 Reactions

  1. Great story to put out!

    A few years ago, I remember talking to a friend of mine. She (at the time) owned a travel agency, and was incorporated. I wasn’t.

    After she told me that I should consider it, I called my small business accountant, and we discussed the idea.

    I’m incorporated.

    It was the way to go for my circumstances.

    (Everybody’s different. Make sure you get the right advice for you.)

    The Franchise King

  2. I converted my business into a C-Corp a few years ago. It was suggested by a friend of mine, who owned a travel agency.

    My CPA agreed, wholeheartedly.

    Every situation is different, so I don’t recommend doing this online. Meet with your CPA, before you embark on a change like this.

    The Franchise King

  3. Plus, if you get it right, there could be some tax savings to incorporation.

  4. I agree with Joel. It all depends on your situation and talking with an accountant about the tax implications will go a long way toward making the right decision.

  5. Although some business structures require more formalities than others, it is imperative that a formally organized/incorporated business have customized/tailored bylaws/operating agreements/partnership agreements to protect the owners if things go south.

  6. My firm just posted an infographic about the different types of business structures in the United States: American Business Entities.

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