Incorporation is an important step in the life of a business, but unfortunately the true value of incorporating a business or forming a limited liability company (LLC) is often not realized until the business faces a negative situation, such as a lawsuit or bankruptcy.
A primary advantage of forming a corporation or LLC is the limited liability these entities afford their owners. Typically, owners are not liable for the debts and obligations of the business; thus creditors cannot pursue the personal assets of the owners to pay the business debts. Conversely, in a partnership or sole proprietorship, where the owner and the business are considered legally the same, the owner’s personal assets may be used to pay debts of the business.
Other advantages of forming a corporation include:
· Incorporating may help to establish credibility for a new business with potential customers, employees, vendors, and partners.
· A corporation’s life is not dependent upon its members. A corporation possesses the feature of unlimited life. If an owner dies or wishes to sell his or her interest, the corporation will continue to exist and do business.
· Retirement funds and qualified retirement plans, such as 401(k), may be established more easily.
· Ownership is typically easily transferable.
· Capital can be raised more easily through the sale of stock.
Other advantages of forming an LLC include:
· Forming an LLC may help to establish credibility for a new business with potential customers, employees, vendors, and partners.
· Earnings of an LLC are passed-through to the owners; therefore they are only taxed once.
· LLCs are free to establish any organizational structure agreed upon by the owners.
· There are few restrictions as to who can be an owner or the number of owners and LLC can have.
· LLCs have fewer state-imposed requirements and ongoing formalities compared to corporations.
The primary disadvantage to forming a corporation is the possibility of double taxation. Profits of a standard corporation (or C corporation) are taxed twice when the profits are distributed to shareholders as dividends. They are taxed first as income to the corporation, then as income to the shareholder. All reasonable business expenses, such as salaries and lease payments, are deductions against corporate income and can minimize the double tax.
Further, the double tax can be eliminated by making the S corporation election with the Internal Revenue Service. Both the S corporation and the LLC allow for pass-through taxation, where the profits of the business are “passed-through” to the owners’ personal tax returns and any tax due is paid at the individual level.
Other disadvantages of corporations and LLCs include:
· More expensive to form than a sole proprietorship or general partnership.
· Both face ongoing requirements, such as state annual report filings.
· Corporations face ongoing formalities, such as holding and properly documenting annual meetings of directors and shareholders.
· Operating a corporation or LLC across state lines may require the company to register with the other state(s) to transact business in that state.
When evaluating whether the corporate structure is right for your particular business, it is advisable to first determine the goals of your business, and then to assess the advantages and potential disadvantages of the different business structures in relation to those goals.
Entrepreneurs face a number of choices when choosing a legal structure for their businesses. BizFilings.com features a convenient tool to help small business owners navigate through each structure’s advantages and disadvantages. The Incorporation Wizard (www.bizfilings.com/wizard.aspx) offers a series of questions to define which business type is suitable. To assist in the decision-making process, they should seek advice from an attorney or accountant.