Now more than ever, forming a corporation or LLC can be a pretty quick and painless process. Yet while the process may be straightforward enough, small business owners can unknowingly make some common missteps that can have a significant impact on the business.
Are you guilty of any of these top incorporation mistakes?
1. Selecting the wrong business structure
Your business entity affects the amount of taxes you pay, the employee benefits you can offer, the amount of paperwork you deal with and more. In the U.S., the three most common business structures are the LLC (limited liability company), S corporation and C corporation. All three entities protect the personal assets of the owners from liability, yet differ when it comes to tax treatment, etc.
- The LLC is great for small businesses that want liability protection, but prefer minimal formality and paperwork.
- The S corporation is a pass-through entity for federal taxes (like the LLC) and is great for small businesses that can qualify.
- The C corporation files its own tax report and should be selected by those companies that plan to reinvest profits back into the company or seek funding from a venture capitalist.
What are some of the common mistakes made when it comes to business entity? For example:
- A public relations consultant creates a C corp for his business, then discovers what “double taxation: means when he files his business and personal tax forms. His CPA advises him to elect pass-through S corp treatment to avoid this the next year.
- Two friends form an S corporation for their new catering business. However, they’re stuck paying taxes in direct proportion to their ownership, even though they’ve actually arranged to allocate the profits 75/25 the first year since one was responsible for significantly more work. Instead of the S corp, they should have formed an LLC so they can have more flexibility when it comes to dividing the profits and their taxes.
2. Picking Delaware or Nevada for the state of incorporation if you have fewer than five shareholders
Many business owners think they should choose between Delaware or Nevada when incorporating or forming an LLC. And, yes, Delaware offers some of the most developed, flexible and pro-business statutes in the country. Nevada offers low filing fees, and has no state corporate income, franchise or personal income taxes. However, these two states aren’t necessarily the best choices for every business.
For the small business (defined here as one with fewer than five shareholders), it’s better to incorporate in the state where you have a physical presence. Otherwise, there can be too many hassles associated with operating out of state. These include difficulties opening a business bank account, having to appoint a registered agent, and fees for operating as a “foreign entity” in your own state.
3. Hiring an attorney to file and send in the incorporation forms
With legal document filing services, you don’t actually need to hire your own lawyer to form an LLC or corporation. In this case, the online service can help you represent yourself to create a business entity. The service can ensure that you have provided all the necessary paperwork right to your state’s specifications. However, a legal document filing service is not allowed to give you advice regarding your specific situation.
Therefore, if you have a particularly complex partnership or financial situation, you should seek the counsel of an attorney.
4. Not keeping your corporation or LLC in compliance
Keeping your LLC or corporation compliant is essential, and continues long after you filed your initial application. A plaintiff may try to show that you have not maintained your LLC or corporation to the letter of the law, and if that attempt is successful, your corporate shield will be pierced, putting your personal assets at risk. To keep your corporation or LLC in compliance, you need to:
- Keep your personal and business expenses separate (this is particularly important if you’ve formed a corporation)
- Send in your Annual Statement/Annual Report on time, as required by your state of incorporation
- File for foreign qualification if you’re operating in any state(s) other than your state of incorporation
- Send in your Articles of Amendment for any key changes to your business
- Don’t engage in any form of fraud.
5. Biggest mistake: Never incorporating at all
The top mistake a small business owner can make is never forming an LLC or corporation in the first place. This puts your key personal assets (savings, retirement fund, property, etc.) at risk.
By avoiding these five common missteps, you can better protect your assets, minimize your liability, lower your expenses and enjoy a legally structured business for years to come.