When To Incorporate Brief

Consider the following general information in deciding when or whether to incorporate your business. There are still other choices than incorporating; for example, forming an Limited Liability Company or a partnership.

THE JOHN SCHACHTER + ASSOCIATES RULE OF THUMB

A business consistently generating more than about $90,000 of profit a year should incorporate – if only for tax reasons. Smaller, or loss-generating businesses may still benefit from incorporation.

STATUS

In some industries, being incorporated raises the perceived stability and legitimacy of the business. Software development is a good example. Does this matter in your line of work?

LIABILITY PROTECTION

In general, a corporation is responsible for its own debts, up to the total of its assets, and no further. For example, if a corporation fails, it could be sued by its vendors, who could take away the corporation’s inventory and equipment, though NOT the owner’s car or house. NOTE: There are significant limits on this protection in a small, closely held corporation. No bank will loan money to a small corporation alone; instead, the bank will require the owner(s) to guarantee repayment personally. Further, liability protection does NOT cover malpractice by an owner/operator of a professional services corporation. In any case, the most appropriate way to manage the risks from the liabilities of the corporation is through insurance, which you need whether or not you are incorporated.

TAX SAVINGS

When you have a corporation, you must be on payroll for a reasonable compensation for the services you perform for that corporation. You get a W2 from the corporation, just as any other employee would. Any profits left over in the corporation when it does its taxes will be taxed, but sometimes at a lower rate than would have been had you not been incorporated. This CAN result in significant tax savings to the business – especially if the owner(s) of the business rent or lease assets to the corporation, or loan it money at interest. But such savings are at least in part offset by the costs of being a corporation: several hundred dollars per year in fees and excise taxes to the state, and perhaps another couple thousand in costs associated with the additional tax return and legal work. In addition, adding yourself to the payroll increases worker’s compensation and unemployment insurance costs. Getting incorporated can cost a couple thousand dollars as well in legal fees and registration costs.

EMPLOYEE BENEFITS

In some cases, good use of a small corporation can be a vehicle to provide tax-favored benefits to the owners. When you have employees, the corporate form can be a good way to let them earn their way into the corporation through stock options or other incentives.

INVESTORS

The best reason to be a corporation: to include investors in your venture. Laws and customary practices surrounding corporations are well known and well-established. Corporations are designed to permit many people to participate in the ownership of a business, without actually running it.

NOTE: These mechanisms require a lot of paperwork, whether the corporation is big or small. For example, decisions of the corporation must be voted on, and minutes kept of annual meetings. This can be a chore, although there is a benefit from making clear the decisions of the corporation if disputes arise among the owners.