The Pros and Cons of Incorporating Your Business

If you're a business owner, you may be considering incorporating your company. While there are benefits to forming a corporation, such as limited liability and potential tax advantages, there are also drawbacks to consider. This article will explore the pros and cons of incorporating, so you can make an informed decision for your business.

What is Incorporation and Why Do It?

Incorporation is the process of forming a legal entity separate from its owners, known as a corporation. A corporation is a distinct legal entity, both for legal and tax purposes. It is deemed to have an existence separate and apart from its owners, the shareholders. A corporation has all of the powers and rights of a natural person, including the right to own property, to sue and be sued, and to enter into binding contracts.

Although owned by its shareholders, a corporation is controlled by the board of directors, which is elected by the shareholders. The shareholders' participation in the management of the corporation is essentially limited to electing the directors and voting on certain major corporate actions. However, shareholders may elect themselves to the board of directors and may still participate in management.

While the directors control and are permitted to manage the corporation, the board of directors generally appoints officers to manage the corporation's day-to-day operations. In smaller corporations, such as S corporations, the shareholders are often also the directors and officers.

The main reason to incorporate is to limit personal liability for business debts and legal issues. By forming a corporation, the owners (or shareholders) are not personally responsible for the company's debts or legal obligations. Additionally, incorporating can provide potential tax benefits and make it easier to raise capital.

The Advantages of Incorporating Your Business.

There are several advantages to incorporating your business. One of the biggest benefits is limited liability protection. As mentioned earlier, incorporating separates the business from its owners, which means that the owners are not personally responsible for the company's debts or legal issues. This can protect personal assets such as homes, cars, and savings accounts.

Additionally, incorporating can make it easier to raise capital by selling shares of the company to investors. Finally, incorporating can provide potential tax benefits, such as the ability to deduct certain expenses and lower tax rates for small businesses.

The Disadvantages of Incorporating Your Business.

While there are many advantages to incorporating your business, there are also some potential disadvantages to consider. One of the biggest drawbacks is the cost and complexity of setting up and maintaining a corporation. Incorporating requires filing paperwork with the state, creating bylaws and other legal documents, and complying with ongoing reporting and record-keeping requirements.

Additionally, some corporations, such as C corporations, are subject to double taxation, meaning that both the company and its shareholders may be taxed on profits. Finally, incorporating can limit the flexibility and control that owners have over their business, as decisions must be made by a board of directors rather than by the owners themselves.

Types of Corporations to Consider.

There are several types of corporations to consider when deciding whether to incorporate your business. The most common types are C corporations and S corporations. C corporations are the most traditional type of corporation and offer the most protection to shareholders, but they are also subject to double taxation.

For legal purposes, an S corporation is no different than any other corporation. However, an S Corporation enjoys certain tax benefits. For instance, an S corporation is considered a pass-through entity, similar to partnerships. In this manner, the S corporation escapes the double taxation on dividend distributions of a C corporation, and the shareholders are allowed to offset losses sustained by the S corporation against their other income. 

Not all corporations may become S corporations.  The corporation must have no more than 100 shareholders, must have only one class of stock, and shareholders cannot be a corporation, LLC, or partnership, among other restrictions.

Factors to Consider Before Making the Decision to Incorporate.

Before making the decision to incorporate your business, there are several factors to consider. One of the biggest advantages of incorporating is the protection it offers to shareholders from personal liability for business debts and lawsuits.

However, incorporating also comes with additional legal and financial responsibilities, such as filing annual reports and paying corporate taxes. It’s important to weigh the pros and cons and consult with professionals before making a decision.

If you have any questions regarding your new business, or would like assistance forming your business, schedule a free consultation with Cutler | Riley Law.