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 a Limited Liability Company or a partnership.
The John Schachter +Associates Rule of Thumb
A business consistently generating more than about $120,000 of profit a year should incorporate – if only for tax reasons. Smaller, or loss-generating businesses may also benefit from incorporation, for example, to claim tax credits or to create losses that can offset profits in later years.
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 W-2 from the corporation, just as any other employee would. Any profits left over in the corporation will be taxed, but sometimes at a lower rate than would have applied 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, which typically include: state fees and excise taxes, and professional fees for increased accounting, tax and legal work. In addition, adding yourself to the payroll increases worker’s compensation and unemployment insurance costs. Getting incorporated also involves 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 an efficient way to let them earn their way into the company 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.
At John Schachter + Associates, we help clients choose the best form for their business. Contact us today if you want to discuss whether incorporation would be right for you.
