When To Incorporate Brief
Consider the following general information in deciding when or whether
to incorporate your business. Please note that there are still other
choices than incorporating; for example, forming an Limited Liability
Company or a partnership.
John Schachter's Rule of Thumb:
A business consistently generating more than about $40,000 of profit a
year should incorporate - if only for tax reasons. Smaller, or
loss-generating businesses may still benefit from incorporation.
1. 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?
2. 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.
3. 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 it 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: around $550 per
year in fees and excise taxes to the state, and perhaps another $500 -
$1500 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 around $500 - $1500 as well in legal fees and registration costs.
4. 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.
5. 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.
|