Are there any reasons why a (very) small business shouldn't incorporate?

Answer 1

As a serial entrepreneur and Adjunt Professor of Business I know how important this is to you. The real question, however, behind incorporating is how do I best protect my personal property. At least that is why the incorporation laws were established. The best reason to incorporate or from a limited liability entity is to keep someone who is sueing from taking ALL of you assets. Under incorporation laws you are establishing an independent non-human legal entity.

With regards to taxes there is a structure in which you can have the gains/losses pass through the entity onto personal tax returns. To do this you could incorporate and request to be granted S-corporation status. Or, you could form a Limited Liability Company (LLC) which automatically passes the tax burden to the owners personal return.

I have included below a portion of my lecture notes that I hope provide you with more insight about some of the things to consider. But I strongly advise you to seek professional legal and financial guidance. The particular business and the equity holders personal tax situation play a huge part in determining the correct path to follow.

---------------------------------------------
➢How to Choose the Legal Form of a Business
• Decide whether you are running the business by your self or with others involved.
• Is it more important to you to have a simple business and tax structure or less personal liability for debts and corporate judgments?
• Will you need to raise a substantial amount of cash?
• Is the business form prescribed by state law / regulation?
• Decide on the duration of the venture.

The type of business form you choose will depend on three primary factors
1. liability
2. taxation
3. record-keeping

➢Legal Forms of Businesses
The basic choices are:
• Sole Proprietorship
• Partnership
• S Corporation
• Limited Liability Company
• C Corporation

I. Sole Proprietorship - .
This is the most common form of business organization. It’s easy to form, and offers complete managerial control to the owner.
• Simplest business form from a tax standpoint.
• Requires the maintenance of records by the individual so that it is possible to determine the income and expenses related to that activity.
• Business income (profit) is reported on a separate IRS tax form, Schedule C. This form is an attachment to the individual’s annual IRS tax form.
• The IRS code allows taxpayer deductions from the gross income (sales), “the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business...”.
• Sole Proprietorship tax rates are sometimes higher than corporate tax rates so there is a need to focus on individual circumstances.


II. Partnerships – General Partnerships.
This involves two or more people who agree to share in the profits or losses of a business.
• A for-profit business association for two or more persons.
• Generally the result of a contract (express or implied) with no formal requirements.
• “Persons” can include individuals, groups of individuals, companies, and corporations
• Highly adaptable in form and vary in complexity.
• Each partner, unless a limited liability partnership, shares directly in the organization’s profits and shares control of the business operation.
• Unlike limited liability partnerships, partners are jointly and independently liable for the partner’s debts.
• State law governs Creation, organization, and dissolution of partnerships.
• Unlike limited liability partnership, under state agency laws, partners are generally liable for torts committed by the partnership and its agents.
• For state and federal income tax purposes, a partnership is not a taxable entity. Partnership income is taxable to the partner in proportion to their share in the company’s profits.
• Automatically dissolved on death of any partner.

III. Partnerships – Limited Liability Partnerships.
• Can only be created where: (1) there is a written agreement among the partners and a (2) formal agreement is filed with the state.
• Two types of partners:
(1) one or more general partners, who are liable for all the debts of the partnership
(2) one or more limited partners, who are not liable for the debts of the partnership beyond the amount they have contributed.
• Limited partners lose their personal limited liability status if they actively participate in the management of the partnership.

IV. Corporations – General Overview.
This is a legal entity created to conduct business.
• A legal “person” which can be created under state law.
• Has right to do business on its own name and the obligation to pay taxes.
• Main reason for having corporation: Allows investors to put up money for new ventures without risk of further liability.

Advantages:
• Limited liability - shareholder’s liability is normally limited to the amount he ha invested. The exception is a corporate officer who does something negligent or corporation does not follow the proper corporate formalities.
• Continuous existence – a corporation unlike a sole proprietorship or partnership may have a perpetual existence.
• Ease of transferability – a corporation and all of its assets and accounts may be transferred by a simple assignment of a stock certificate. With a sole proprietorship or partnership, each of the individual assets must be transferred and the accounts, permits, and licenses must be individually transferred.
• Ownership can be transferred without giving up control. – By distributing stock, the owner of a business can share the profits without giving up control.
• Ease of raising capital – A corporation may raise capital (money) by selling stocks (% ownership interest) or borrowing money. A corporation doesn’t pay taxes on the money it raises by the sale of stock.
• Separate record keeping – Requirement for corporations that avoids confusion found in partnerships and sole proprietorships where business and personal accounts might be mixed.
• Tax advantages – Several tax advantages that are available only to corporations.
• Separate credit rating – A corporation has its own credit rating. A corporate business can go bankrupt and the shareholder’s personal credit will remain unharmed.

Disadvantages:
• Extra tax return and annual return. – Corporations are required to file its own tax return and typically must file, annually a simple report.
• Separate records – Shareholders of a corporation must be careful to keep personal business separate from the business of the corporation.
• Checking Account – Checks made out to a corporation must be deposited into a corporate account – cannot be cashed by a shareholder.

V. Corporations – S Corporation.
• Can make this election at beginning of existence or at beginning of corporate year.
• May only be used for small businesses.
• All income or losses passed through to the shareholders who report them on individual returns.

Advantage:
• Avoids double taxation and allows the pass-through of losses and depreciation.

Disadvantages:
• If stockholders are in a high income tax bracket, their share of the profits will be taxed at those rates.
• Some fringe benefits such as health and life insurance may not be tax deductible.

VI. Corporations – C Corporation.
• A C-corporation pays taxes on its net earnings at corporate rates.
• Salaries of officers, directors, and employees are taxable to them and deductible to the corporation (standard business expense).
• Money paid out in dividends is taxed twice – taxed at corporate rate as part of the profit and, when distributed to stockholders, at the individual stockholder’s rate as income.

Advantages:
• If taxpayers are in a higher bracket than the corporation and the money will be left in the company for expansion, taxes will be saved.
• Fringe benefits are deductible expenses.

Disadvantages:
• Double taxation
• Most states have an income tax that only applies to C-corporations and applies to all income over a certain amount.

VII. Corporations – Limited Liability Company (LLC).
This is a hybrid-formation; It’s partnership meets corporation. This is the newest legal formation and is very popular.
• A legal “person” which can be created under state law.
• “Persons” can include individuals, groups of individuals, companies, and corporations
• Allows investors to put up money for new ventures without risk of further liability.

Advantages:
• Taxability - Profits & losses are pass-through to the owners without taxation of the business
• Limited liability - member’s liability is limited to the amount he has invested.
• Flexible Management Structure
• Flexible Distribution of Profits & Losses .
• Ownership can be transferred without giving up control.
• Ease of raising capital.
• Separate record keeping
• Separate credit rating
Disadvantages:
• Separate records.
• Checking Account

VIII.Joint Ventures (JVs).
• A legal organization that takes the form of a short-term partnership on which person jointly undertake a transaction for mutual profit.
• Generally each person contributes asset and shares risks.
• Like a partnership, a joint venture can involve any type of business transaction and the “person” involved can be individuals, groups of individuals, companies or corporations.
• Governed by state partnership, contract, and commercial transactions law.
• Treated like a partnership for federal income tax purposes
• JV corporation involves same type of activity, except that it is structured within a corporate framework.

Answer 2

If you are a very small business with no investors and no capacity at this point to attract investors, starting out as a corporation may be more than a hassle. Here are why a very small business should not incorporate:

- Corporations are taxed twice.
- Corporations must pay capital stock tax.
- Starting a corporation is expensive.
- Corporations are closely regulated by government agencies.

The main disadvantage of the corporate form can be summed up in two words: taxation and complexity. In what amounts to double taxation, you must pay taxes on both the income the corporation earns and the income you earn as an individual. Along with this, corporations are required to pay an annual tax on all outstanding shares of stock. Given its complexity, a corporation is both more difficult and more expensive to start than are the sole proprietor­ship and the partnership. In order to form a corporation, you must be granted a charter by the state in which your home-based business is located. For a small business the cost of incorporating usually ranges from $500 to $1,500. This includes the costs for legal assistance in drawing up your charter, state incorporation fees, and the purchase of record books and stock certificates. And, since corporations are subject to closer regulation by the government, the owners must bear the ongoing cost of preparing and filing state and federal reports.

Answer 3

You should seriously consider forming an LLC. (Limited Liability Company)

No double taxation. (like sole proprietorship)
It is a separate legal entity to protect its member(s). (like corporation)
It is inexpensive to form. It is flexible. If I were to start a small business, it is what I would use and what I recommended when I was a small business counselor (most of the time).

For more info:
http://business-law.freeadvice.com/corporations/322/
http://www.toolkit.cch.com/text/P12_4960.asp

Go to a local SCORE or SBDC (small business development center at a university) if you want to talk to someone personally. They are both FREE and a good place to start before paying momey to lawyers or accountants.

Answer 4

Here is an answer I gave one the ads & the disads of a sole proprietorship.

ads-flow through of taxation, management control (you don't have to share ownership with anyone else), no double taxation of dividends like a corp(once at corporate level, once at shareholder level(you))

disads-no continuity of interest (if you die, business dies), sometimes harder to raise capital (as a corp, you can give shares in corp for money), unlimited liability (if business fails, debtors can go after your assets)

Let me know if you have any more questions.

An accountant would be great to consult with for additional info-they should be very knowledgeable on the topic.

Answer 5

make sure you check out the tax laws. sometimes it just doesn't pay to incorporate. but the irs.gov website can help you decide. they have info on all the different types of things like incoportation, llc...etc