Do you know the difference between an S Corp and a C Corp? Have you ever wondered if you should form an LLC for your business or where you should incorporate? Or maybe you’re not sure if you need to create a non-profit for your activities? These are just a few of the frequently asked questions about incorporation.
Assembled below are all the answers to the most frequently asked questions when it comes to incorporating your business. If you’re a small business owner, read on to learn more about the various business structures and how you should incorporate your business.
Frequently Asked Questions About Incorporation
1. What are the benefits of incorporation?
The main reason to incorporate (or form an LLC) is to minimize your personal liability. Once your business is incorporated (either by forming an LLC or Corporation), it exists as a separate business entity. Essentially, you put a wall separating your personal assets from anything in the business.
Of course, there are other benefits too. Here are the top reasons to incorporate:
1. Minimize your personal liability and protect your personal assets.
2. Get more flexibility when it comes to taxes (talk to your CPA or tax advisor for specific advice on your personal situation).
3. Boost the credibility of your small business.
4. Add a layer of privacy (don’t use your personal name and home address to represent your business).
5. Start building your business credit.
6. Protect your business name and brand at the state level.
2. What are the drawbacks of incorporation?
The only real “drawback” of incorporating is that you’ll need to operate your business at a higher administrative level than you’re used to as a sole proprietorship. In addition, incorporating as a C Corporation can result in higher taxes for some small business scenarios due to double taxation.
With a C Corporation, the business needs to pay taxes on any profits, and then owners are also taxed when any profits are distributed to them. Obviously, if you’re looking to put your small business profits into your own pocket, you may end up paying a lot in taxes. However, as the following question shows, there are ways to avoid double taxation while still getting some of the benefits of incorporation.
3. What’s the difference between a C Corp and an S Corp?
As mentioned above, the C Corporation’s tax structure isn’t optimal for many small businesses, since business owners often are taxed twice on the profits. However, Corporations can elect for “S Corporation” tax treatment. Often called a “pass-through” entity, an S Corporation doesn’t file its own taxes. Rather, profits and losses of the business are passed through and reported on the business owner’s personal tax return.
To qualify for S Corporation tax treatment, you’ll need to fill out Form 2553 with the IRS. You’ll need to do this no more than 75 days from the date of incorporation, or no more than 75 days from the start of the current tax year.
Be aware that not every business can qualify to be an S Corporation. For example, an S Corporation cannot have more than 100 shareholders and shareholders must be U.S. citizens or residents.
4. What’s an LLC?
An LLC (Limited Liability Company) is a hybrid of a sole proprietorship/partnership and corporation. This structure is very popular among small businesses, and for good reason. The LLC limits the personal liability of the owners, but doesn’t require much of the heavy formality and paperwork of the corporation. This makes it a great choice for business owners that want liability protection but don’t want to deal with exhaustive meeting minutes, addendum filings or other paperwork you’d need to file as a corporation.
You can structure your LLC to be taxed as an S Corporation (as described above) where company profits flow through to the owners and are taxed at the personal income rate.
5. What’s a non-profit corporation?
A nonprofit is created for charitable, educational or other purposes (actually there are five recognized purposes: charitable, religious, scientific, educational and literary). Nonprofits cannot benefit the owners: all money above operating costs must be used to further the goals of the nonprofit. This allows nonprofits to operate tax-free. Approval is needed at both at the State and Federal (IRS) level.
Just like with other corporations or LLCs, a nonprofit corporation offers a corporate shield that helps protect the personal assets of the nonprofit’s stakeholders. In most cases, as long as the legal structure remains correct, stakeholders of nonprofit corporations are immune from individual liability.
6. Where should I incorporate?
You often hear of companies incorporating in Delaware, Wyoming or Nevada. That’s because Delaware offers flexible, pro-business statutes, while Wyoming and Nevada feature low filing fees as well as no state corporate income, franchise or personal income taxes.
However, as a general rule of thumb, if your business will have fewer than five shareholders, you should incorporate in the state where you actually live or where your business has a physical presence (such as an office.) When you incorporate in a different state from your physical presence, you’ll need to deal with added fees and paperwork, since you’re considered “operating out of state.” And for most small businesses, the added hassle and fees just aren’t worth it.
7. When is the best time to incorporate?
In most cases, it’s best to incorporate or form an LLC as soon as possible. After all, the main benefit is liability protection and by waiting to incorporate, you can be exposing yourself to liability.
Keep in mind that your corporation’s start date is not retroactive. This typically means filing two business income tax returns for the year. For example, if your corporation was formed on June 1, you’ll need to file as a sole proprietor (or whatever your previous entity may have been) from Jan. 1 – May 31 and then file as a corporation from June 1 – Dec. 31.
8. How can I incorporate?
There are three common methods for incorporating or forming an LLC. Each has its pros and cons, depending on your needs:
- Do-it-yourself: DIY is the lowest cost method, but you’ll need to do everything yourself. This is the best option if you’re more interested in saving money than time. With this route, you need to be able to deal with lots of details and arbitrary rules.
- Online legal filing service: This option is slightly more expensive than DIY. An online legal filing service will complete and file the documentation for you. Like any legal document, the articles of incorporation and application are full of tedious details. A professional service can make sure that your application is done right and processed smoothly.
- Lawyer: This is the most expensive option, but may be necessary in certain situations. For example, if you have complex requirements for how your stock should be allocated or you are working with millions of dollars, then you should turn to expert advice.
Whichever method you choose, you may want to speak with a tax professional to determine what business structure will be the best for your particular circumstances.
More in: Legal Structure
Thanks for the valuable info, Nellie. I never quite understood the difference between the different kind of biz’s so this was truly helpful to me.
Great info, Nellie!
I’m so grateful that a friend of mine suggested that I incorporate my business several years ago.
No looking back!
The Franchise King®
While incorporating can be a good strategy, be aware that there are additional costs besides the potential extra taxes for a C Corp. Most states charge an annual tax or fee (in California it’s $800), and you will need to pay to have an additional tax return prepared (and preparing a corporate tax return can be pricey due to additional reporting requirements). It still makes sense to incorporate but be aware of those additional costs! You will also need to track balance sheet items much more carefully. I wouldn’t recommend the do-it-yourself incorporation.
For those folks wishing to put social purpose or mission before profit there is also the L3C – a variant of the LLC which you can organize currently in 9 states but is recognized in all 50 states. Our firm interSector Partners, L3C was the 39th L3C to organize in the US back in February 2009 and the first operating in Colorado.
There is also the Benefit Corporation – a new class of corporation currently available in 12 states that 1) creates a material positive impact on society and the environment; 2) expands fiduciary duty to require consideration of non-financial interests when making decisions; and 3) reports on its overall social and environmental performance using recognized third party standards.
In Maryland you can file as a Benefit LLC which allows for the ability to build environmental and social commitments into your company’s legal charter.
The Flexible Purpose Corporation is another option. A flexible purpose corporation is a class of corporation in California which is free from the corporate requirement to maximize profit when adhering to at least one “special purpose” defined in its charter. Flexible purpose corporations must specify at least one such “special purpose” which describes a social benefit. A flexible purpose corporation differs from a Benefit corporation in that it targets for-profit entities seeking traditional capital market investment.