Is it a good idea to incorporate your small business? When is the best time to use it? I'm sure you've heard that incorporating may save you a lot of money in taxes – is that true? What are the advantages and disadvantages of incorporating your company?
These inquiries take numerous forms, and the problem is complicated. This article on company incorporation will explain the benefits and drawbacks of doing so, as well as other topics. Continue reading!
Table of Contents
- What Does Corporation Mean?
- Three Reasons Why is Corporation Required to Carry Your Firm
- Why Should You Consider Incorporating Your Business?
- Four Questions to Ask Yourself Before Incorporating Your Small Business
- 1. What level of legal protection do you require?
- 2. What is your annual income?
- 3. Does your company require its own credit?
- 4. What is your long-term company strategy?
- Five Advantages of Incorporating Your Business
- When Shouldn't You Think About Incorporating?
- Final Thoughts
- How can Deskera Help You?
- Key Takeaways
- Related Articles
What Does Corporation Mean?
The word corporation is derived from the Latin word corpus, which means "body." In the viewpoint of the law, a corporation is a body; it is a legal person. It has the ability to file lawsuits, purchase and sell property, enter into contracts, pay taxes, and even commit crimes. Its most famous characteristic is that, within certain restrictions, a corporation protects its owners from personal culpability for company debts and obligations.
The company is seen as a man-made legal body that exists independently of the humans who founded it and carry out its operations. A company can be founded with as little as one incorporator by simply filing an application for a charter with the appropriate state.
The incorporator will place facts on record by filing this application, such as:
- the proposed corporation's mission,
- the incorporators' names and addresses,
- the quantity and categories of capital stock that the company will be permitted to issue, as well as
- the rights and benefits of each stock class's holders
Three Reasons Why is Corporation Required to Carry Your Firm
- Unlimited life:
The existence of a corporation, unlike that of a proprietorship or a partnership, is not based on the life of a single individual or individual. It can carry on eternally until it achieves its goal, merges with another company, or declares bankruptcy. It might continue indefinitely until otherwise indicated.
- Transferability of shares:
It's always comforting to know that your business ownership stake may be easily sold, transferred, or passed down to another family member. The process of selling your shares in sole proprietorships and partnerships can be time-consuming and expensive. Any time there is a change of ownership, the property must be retitled, new deeds created, and other administrative actions must be done. Individual owners' rights and privileges are reflected by the shares of stock they possess in corporations.
On the back of each stock certificate, there is normally a space specified for the shareholder to endorse and sign over any shares that are to be sold or otherwise disposed of, and this is the key to a swift and effective transfer of control of the corporation.
- Ability to raise investment capital:
Because of the restricted liability and simple transferability of shares, it is typically considered easier to attract new investors to a corporate body. Shares of stock can be transferred directly to new investors, or brokerage companies and stock exchanges can be enlisted when bigger public offerings are required.
Why Should You Consider Incorporating Your Business?
True, there are certain disadvantages to becoming a company in some cases. As a business owner, for example, you would be responsible for additional record-keeping and administrative issues. More importantly, functioning as a company might sometimes result in an extra tax burden. This is the very last thing a business owner wants, especially in the early stages.
Apart from tax considerations, the most typical rationale for paying the cost of forming a corporation is the realisation that the shareholder is not legally accountable for the organization's activities. This is because the corporation exists in its own right, independent of the people who govern it.
Four Questions to Ask Yourself Before Incorporating Your Small Business
1. What level of legal protection do you require?
Your personal and company assets are the same if you run an unincorporated firm. If your company is sued, you are insulated from personal liability as an LLC or incorporated entity. There are exceptions, but in general, the company owner has a legal barrier between their personal assets and their firm.
You're also not personally accountable for your organization's obligations unless you sign a personal guarantee, much like an LLC or incorporated business. This implies that you may only pay back debts with assets controlled by your company. If you have personal assets, such as a home, car, or other personal property, this is very crucial.
What level of legal protection do you require? Your industry and the items or services you provide will determine this. A virtual assistant, for example, faces far less legal danger than someone who offers consumable goods.
Consider how vulnerable your company is to potential legal issues:
- Do you sell or manufacture things that are intended to be consumed or applied to a person's skin? Food, vitamins, supplements, herbs, and skincare products are examples.
- Do you have a physical place where clients might be injured if something goes wrong?
- Do you have workers, and do you want to be held responsible for their actions?
If your company faces considerable legal dangers, you should consider incorporating it for legal protection.
2. What is your annual income?
From a financial viewpoint, incorporation makes sense for certain business owners. S and C corporations pay different taxes than single proprietors. For company owners, these tax changes may be quite beneficial.
When you're taxed as an S corporation, you only pay income tax on the earnings of your company. Unlike LLC or sole proprietorship owners, who pay income tax and self-employment tax on their earnings, S corp owners do not pay self-employment tax, which is 15.3% of their profits.
As an S corporation, however, you are required to pay yourself "fair remuneration" through payroll. Your employer will pay half of your payroll taxes (7.65%), and you will pay the remaining 7.65% through withholdings from your paycheck. This implies that you only pay self-employment tax on your compensation, not on your whole earnings.
As a C corporation, you pay corporate tax on your profits, but the owners only pay income tax on the dividends you give them. You are only taxed on the earnings that are distributed to you as the owner, not on the overall profit of your firm.
If you simply receive a salary from your C company (which is subject to payroll taxes) rather than dividends, your corporation will be the only one to pay taxes on the earnings. The corporation tax rate has been reduced from 35% to 21% under the new tax plan, which might result in even more financial savings.
In general, if you earn more than $60,000 in taxable earnings each year, incorporating your business might save you a lot of money in taxes. If you fall within this range, consult a tax advisor to see if incorporation is right for you.
3. Does your company require its own credit?
When you incorporate your company, it becomes its own legal entity with its own credit. Businesses, like people, have their own credit records and ratings. Businesses, like people, may improve their credit over time.
- When your company has its own (hopefully decent) credit, you may do the following:
- Make an application for a business financing
- Open a credit card for your business.
- Open a business credit line.
- Set up trade lines (also known as payment terms) with your suppliers.
And you may do it all in the name of your company. As a result, your personal credit is kept separate from your company credit. This also means that you are not personally accountable for the debts incurred by your company.
"I don't need a business loan!" You may argue, but keep in mind that merit is earned over time. You may not require a loan right now, but will you require one in five years?
For example, suppose you own a modest online business and want to open a physical presence. You may not be ready for it right now, but if it's in your five-year plan, it's a smart idea to start establishing your company credit now so you can qualify for a loan later.
Consider establishing your firm now if you anticipate you'll need a business loan or to arrange payment terms with your vendors in the following five years. This will give you more time to improve your business credit.
4. What is your long-term company strategy?
It's easy to get caught up in the day-to-day operations of our businesses and lose sight of our long-term objectives. However, your long-term objectives should be a major consideration when deciding whether or not to incorporate your company.
- Do you plan to sell your company at some point? Then you'll need to incorporate your company so that you may sell things. Remember that when you incorporate your company, it becomes its own legal entity that exists whether or not you are the proprietor.
- Do you intend to seek out funds and investors? Investors are less willing to invest in unincorporated enterprises and prefer to put their money into companies that can issue shares.
- Will you seek contracts with clients that need their business to be incorporated? Some businesses will not do business with unincorporated firms. Incorporating your company provides up to more opportunities in terms of clients and might improve your company's repute.
Will you be developing a brand that requires protection? When you form a corporation, you must register your company name with the state. No one else in the state can use your company's name once you've registered it. Protect your brand by incorporating your company if you're starting a firm that will rely largely on brand awareness.
Five Advantages of Incorporating Your Business
1. Safeguard Your Personal Property
One of the most effective strategies to preserve your personal assets is to incorporate your company. A corporation has the power to own property, do business, enter into contracts, and sue or be sued.
A company is accountable for its own debts as a distinct legal entity. That implies that a corporation's creditors may normally only seek payment from the corporation's assets, not from the personal assets of its shareholders, directors, and officials. In practice, this implies that company owners may perform their operations without putting their houses, automobiles, funds, or other personal belongings in danger. A sole proprietorship or partnership, on the other hand, exposes its owners to limitless responsibility for both business and personal assets.
2. Have Easier Capital Access
Because a business may issue stock, it is often simpler for it to get funds. This might make it simpler for your company to expand and prosper. If you're searching for bank finance, incorporating is also a good idea. In most cases, banks tend to lend money to corporations than unincorporated firms. Corporations, overall, have greater accessibility to other income sources for paying off debt.
3. Boost Your Company's Credibility
Beyond financial concerns, there are several advantages to establishing a business. Corporations are frequently seen as more stable than unincorporated firms by suppliers, consumers, and business colleagues. In some instances, putting "Inc." or "Corp." to the close of your company name demonstrates permanency, reliability, and stability, as well as your commitment to your organization's long-term success.
4. Universal Existence
Corporations are the most durable legal structure of a business. Regardless matter what happens to its individual directors, officers, managers, or stockholders, a company can remain perpetually. This implies that by incorporating your company, you may be able to avoid the legal complications that alternative business formats may cause.
5. Protect your anonymity
A company can provide its owners with anonymity. If you want to start a small business but don't want your involvement to be known, incorporating can be the best option.
When Shouldn't You Think About Incorporating?
In some cases, incorporating your company isn't the best option. These include the following situations:
- You just cannot afford it. Incorporation entails significant up-front and continuing fees, which vary by state. You also risk incurring interest and fines if you fail to file your reports on time.
- You don't want to cope with the responsibilities and deadlines that come with running a company.
- Your company is in jeopardy. It makes more sense to put the money towards enhancing your business in order to strengthen your startup's prospects of survival.
- You regard your company as a side hustle or a pastime, and you have no plans to hire workers or go public.
Before deciding to incorporate your company, you should consult with your accountant and lawyer about your unique situation. They'll be able to offer you a more detailed picture of how incorporation may benefit your company and help you decide if the hassle and price of doing so are worth it.
How can Deskera Help You?
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- In the viewpoint of the law, a corporation is a body; it is a legal person. It has the ability to file lawsuits, purchase and sell property, enter into contracts, pay taxes, and even commit crimes.
- Unlimited life, share transferability, and the ability to raise investment capital are the main reasons why a corporation is essential to carry your business.
- There are certain questions that have been mentioned in this article that you should consider before incorporating your business.
- Before deciding to incorporate your company, you should consult with your accountant and lawyer about your unique situation