Want to give your small start-up the look of a big business? One way is to add "Inc." to your business name by choosing incorporation as your legal form of doing business.
"Your business can appear more substantial, more established, when you're incorporated," says Caroline Quigley, executive vice president of Inc. Plan (USA), a Wilmington, Delaware, company that helps businesses incorporate. "It's one thing to do business as `Jane Smith,' but doing business as `Smith Public Relations Inc.' gives the business added stature."
Incorporating does more than just boost your image, however. When you incorporate your business, you create a separate legal entity with a life of its own. Unlike a sole proprietorship or a partnership, a corporation can survive your death. A corporation is recognized by local and state governments and has legal rights and responsibilities. For example, it can buy and sell property; it can sue and be sued; and it pays taxes.
Probably the single most important function of incorporating is to protect your personal assets. Should your incorporated business fail, your personal assets are generally protected from creditors (unless you've guaranteed a loan or done something illegal). All the corporation's assets would go toward satisfying its debts, but no one can attach your house, car or personal bank account to pay outstanding claims. In effect, your personal liability is limited to the amount of money you put into your corporation, with the exception of any unpaid taxes.
There are other reasons to consider incorporating. When you want to raise capital for your business, it's easier to attract investors if you're incorporated. An investor can purchase shares of stock in your corporation in exchange for the money you receive. Corporations enjoy tax advantages that single proprietorships and partnerships don't. For example, you can set up pension, profit-sharing and stock-option plans for yourself and other owners of the corporation.
There are, of course, some disadvantages to incorporating a small business. Record-keeping can be time-consuming. You need to maintain accurate financial records for your corporation and keep them separate from your personal expenses. Depending on the type of corporation you set up, you might have to file two tax returns, individual and corporate, which can mean added accounting expenses.
Second, you could encounter some personal risks. While shareholders of a corporation are not personally liable for corporate debts, major shareholders--yourself included--might be asked to personally guarantee loans made to the corporation. Probably the biggest drawback is the potential for double taxation. A corporation's income is taxed by the federal government and by most states. Then, when income is distributed as dividends to shareholders, it's taxed a second time at the personal level.
You can avoid double taxation by applying to the IRS to form an "S" corporation rather than the standard "C" corporation. "[An S] corporation is taxed similarly to a partnership," explains Quigley. "Each shareholder reports profits or losses of the corporation on his or her personal tax return in proportion to the amount of shares he or she holds." If your corporation incurs a loss, you can use it to offset other tax obligations. If there's a profit, it's taxed once--at your personal income-tax level--rather than twice, as with a "C" corporation.
To maintain the advantages of incorporating, it's critical you maintain what's commonly called "the integrity" of the corporation. Requirements vary from state to state. At a minimum, you'll need to hold a documented annual meeting of corporate officers and submit an annual report to the secretary of state.
You can get into trouble and lose the protection a corporation affords you when you "pierce the corporate veil." This typically happens when officers use corporate funds to pay personal expenses. Creditors and others with claims against your corporation can then sue you and go after your personal assets.
Who can help you incorporate? There are plenty of do-it-yourself books and software programs you can use (see "Resources" on page 22). Generic forms and filing fees could cost as little as $200, depending on where you incorporate. You might, however, want to hire an attorney to draft or at least review your documents. It's good protection for your corporation.
A third option is to pay a company to draw up and file the documents for you. Inc. Plan (USA)'s incorporation fees range from $119 in Delaware to $1,009 in California. The process typically takes two to three weeks, depending on the state. Two companies providing similar services are CT Corporation System (800-624-0909) and Corporate Agents Inc. (800-877-4224).
Carla Goodman is a freelance writer in Sacramento, California.