Using the corporate structure is more complex and expensive than most other business structures. A corporation is an independent legal entity, separate from its owners, and as such, it requires complying with more regulations and tax requirements.
The biggest benefit for a small-business owner who decides to incorporate is the liability protection he or she receives. A corporation's debt is not considered that of its owners, so if you organize your business as a corporation, you're not putting your personal assets at risk. A corporation also can retain some of its profits, without the owner paying tax on them. Another plus is the ability of a corporation to raise money. A corporation can sell stock, either common or preferred, to raise funds. Corporations also continue indefinitely, even if one of the shareholders dies, sells the shares or becomes disabled.
The corporate structure, however, comes with a number of downsides. A major one is higher costs. Corporations are formed under the laws of each state with their own set of regulations. You'll probably need the assistance of an attorney to guide you through the maze. In addition, because a corporation must follow more complex rules and regulations than a partnership or sole proprietorship, it requires more accounting and tax preparation services.
Another drawback: Owners of the corporation pay a double tax on the business's earnings. Not only are corporations subject to corporate income tax at both the federal and state levels, but any earnings distributed to shareholders in the form of dividends are taxed at individual tax rates on their personal income tax returns.
To avoid double taxation, you could pay the money out as salaries to you and any other corporate shareholders. A corporation is not required to pay tax on earnings paid as reasonable compensation, and it can deduct the payments as a business expense. Keep in mind, however, that the IRS has limits on what it believes to be reasonable compensation.
How to Incorporate
To start the process of incorporating, contact the secretary of state or the state office that is responsible for registering corporations in your state. Ask for instructions, forms and fee schedules on business incorporation.
It's possible to file for incorporation without the help of an attorney by using books and software to guide you along. Your expense will be the cost of these resources, the filing fees, and any other costs associated with incorporating in your state.
If you do file for incorporation yourself, you'll save the expense of using a lawyer, which can cost from $500 to $1,000. The disadvantage of going this route is that the process may take you some time to accomplish. There's also a chance you could miss some small but important detail in your state's law.
One of the first steps you must take in the incorporation process is to prepare a certificate or articles of incorporation. Some states will provide you with a printed form for this, which either you or your attorney can complete. The information requested includes the proposed name of the corporation, the purpose of the corporation, the names and addresses of the parties incorporating, and the location of the principal office of the corporation.
The corporation will also need a set of bylaws that describe in greater detail than the articles how the corporation will run, including the responsibilities of the shareholders, directors and officers; when stockholder meetings will be held; and other details important to running the company. Once your articles of incorporation are accepted, the secretary of state's office will send you a certificate of incorporation.
Once you're incorporated, be sure to follow the rules of incorporation. If you don't, a court can pierce the corporate veil and hold you and the other owners personally liable for the business's debts.
It's important to follow all the corporation rules required by state law. You should keep accurate financial records for the corporation, showing a separation between the corporation's income and expenses and that of the owners'.
The corporation should also issue stock, file annual reports and hold yearly meetings to elect officers and directors, even if they're the same people as the shareholders. Be sure to keep minutes of these meetings. On all references to your business, make certain to identify it as a corporation, using Inc. or Corp., whichever your state requires. You also want to make sure that whomever you deal with, such as your banker or clients, knows that you're an officer of a corporation.