Whether you’re just considering a new business idea or already act as a sole proprietorship or general partnership, you may wonder if incorporating your business is right for you. Discover why the benefits of incorporation can outweigh any downsides.
Key takeaways:- Incorporation is the process of creating a corporation by filing Articles of Incorporation with the state.
- Incorporation offers benefits including limited liability protection and tax advantages.
- Corporations must meet legal obligations to maintain benefits.
What does it mean to incorporate your business?
When you incorporate your business, you are forming a corporation, a legal entity that exists independently from its owners (called shareholders). Some people use the term "incorporation" to refer to creating any kind of legal business entity, such as an LLC. However, it technically refers specifically to forming a corporation.
Individuals, organizations, or existing businesses can form a corporation. Once incorporated, the corporation can engage in business, enter contracts, borrow money, own property, and more. But incorporating also brings with it legal obligations such as franchise tax filings and annual reports. Meeting these requirements is vital for preserving the legal protections and benefits that incorporation provides.
To incorporate your business, you must file Articles of Incorporation with a state agency. These formation documents include information about your business purpose, location, and shares of stock to be issued.
For more information, see our guides on how to start a corporation and how to form an LLC.
What are the advantages of incorporating your business?
There are many advantages to incorporating to both the business and the owners. Forming a corporation allows you to:
- Secure your assets. One of the main advantages of forming a corporation is limited liability protection. This means that as an owner, you’re typically not personally responsible for business debts. For example, creditors can’t pursue your home or car to pay business debts. Note: LLCs also provide limited liability protection. Sole proprietorships and general partnerships do not.
- Gain tax advantages. Another benefit to incorporation is access to certain tax advantages. Corporations may deduct expenses such as health insurance premiums and life insurance. If the corporate tax rate is lower than the personal rate and/or your corporation does not distribute income to shareholders, the business may realize additional tax savings.
- Gain credibility and perpetual existence. Incorporating bolsters credibility and may help attract new customers and partners. And while you can’t live forever, your corporation can. Even if an owner dies or sells interest, the corporation still exists.
- Transfer ownership and raise capital more easily. Corporation ownership can be transferred relatively easily (with some restrictions on S corporations). You can raise capital by selling stock, and many banks prefer lending to incorporated businesses.
- Establish retirement plans. Corporations can more easily set up retirement funds and qualified plans, like a 401(k).
- Maintain privacy. If you prefer to keep your involvement in a business private, incorporating may help limit disclosure of ownership to the general public.
What are the disadvantages of incorporating your business?
Corporations do have some potential disadvantages, including:
- Double taxation. C corporations are subject to double taxation when corporate profits are distributed as dividends. Corporations are liable for reporting and taxing business profits first. Any remaining profits distributed to shareholders in the form of dividends that must be reported as personal income by shareholders and taxed accordingly. The IRS allows companies to elect S corporation tax status to avoid this disadvantage.
- Compliance obligations. Corporations (as well as LLCs) must meet ongoing state compliance requirements, such as maintaining a registered agent and filing annual reports. Sole proprietorships and general partnerships are not subject to these obligations.
- Initial and ongoing fees. Filing articles of incorporation comes with state fees that vary by location. Many states also impose annual franchise taxes and report filing fees throughout the life of your corporation.
- Record keeping. Corporations must follow formal record-keeping requirements that sole proprietorships, general partnerships, and limited liability companies (LLCs) don’t face.
Should I incorporate my business?
Your choice of business structure can impact everything from daily operations to taxes to the risk exposure of your personal assets.
Business structures like corporations and LLCs offer significant advantages, but only if you meet their formation, management, and compliance requirements. Failing to maintain proper compliance can put those benefits at risk.
It’s a good idea to consult with a professional, such as a small business counselor, tax advisor, attorney, or accountant. You can also use this BizFilings Incorporation Wizard Tool to see which business type is right for you.
For more information, read: Comparing company types: Understanding C Corp, S Corp, LLC and DBA business structures and Business compliance requirements.
