Choosing your business to incorporate is a big step that will affect many different parts of your business. The decision for the business to incorporate is not without its risks. Corporations can either be “C corporations” or “S corporations.” C corporations must have at least 75 investors, making them significantly larger than S businesses.
Smaller than C corporations, S corporations have fewer than 75 stockholders. Forming a corporation is the most complicated of all the ways to start a business. Costs to form a business to incorporate vary from state to state.
1. Asset Protection.
According to NY Biennial Statement Online, one of the most important reasons for a business to incorporate is to protect the owners’ personal assets. Creating a corporation independent from its owners provides a number of benefits. This means that your business can build up assets and debts that are separate from your own.
Incorporating your business is also helpful because it lowers your liability. For example, if a creditor or other third party sues your business. There is a chance that you to lose your house or other personal assets than if you were a sole proprietor. Most of the time, creditors can only go as far as your ownership stake in the business to get their money back.
2. Separate Personal from Business.
When you run your business as a sole proprietorship or a partnership, the business and the owner are the same thing. In this case, the business is the people who run it. They are personally responsible for signing contracts and getting loans or lines of credit.
Also, if the business has any kind of problem (like a customer suing or creditors taking legal action), the owners are personally responsible. This means that your property and savings could be at risk.
One important reason for a business to incorporate or form an LLC is to protect the owners or stockholders from personal liability. With these formal business structures, there is a differentiation between the owner from the business. As long as the company follows all the rules for being a corporation, creditors and court orders can’t usually take an owner’s personal assets to pay off the company’s debts.
People usually want to form an LLC before launching a product or service because the risk of liability goes up when you add customers, users, or clients.
3. Limited Liability for Shareholders.
Corporations are the best way for business owners, also known as shareholders, to protect themselves from business liability. This means that the law protects your personal assets. So that they can’t be taken to pay off corporate debts, like those owed to creditors.
The law treats corporations in a unique way, apart from their owners. Corporations:
- Pay their own taxes.
- Own their own property.
- Sign contracts.
- Sue and are sued on their own.
As long as your corporation is running as a separate entity, shareholders are not responsible for business debts.
There are some exceptions to this, and shareholders can be held personally responsible. If the corporation is set up wrong if someone personally guarantees a debt or credit. Or if there is a mix of funds so that the shareholder and the business are acting like one.
To really take advantage of the liability protection that corporations offer, they must be set up, run, and kept as separate entities. Corporations have been able to protect shareholders from business liability for many years. The court could see through the corporate veil if the company was utilize to trick a creditor or if it had too little money to try to trick a lender.
So, there could be ignorance of corporate structure. Moreover, the owners of the business are holding personally responsible for the business:
When running a corporation, it is important that your business is set up correctly and that you follow the rules and keep a separate status.
The extra credibility that comes with being an official corporation is another reason why small businesses incorporate. Those three letters, Inc., can give your business a lot more credibility with:
- Even possible lenders.
When you incorporate, the rest of the world knows that you are a real business. Getting your business to incorporate can even help you get a loan for your business.
Banks may be more likely to give money to a well-known corporation than to a small business that doesn’t stand out. When you incorporate, you can use the corporation’s name to open business accounts and borrow money.
When you have a corporation, you may also find it easier to get funding and investors. Your investors can become owners instead of just lending you money, which may be more appealing. And some investors and lenders will ask for it.
5. Raising Capital.
When you turn your business into a corporation, it’s much easier to get the money you need for it. Corporations often find it easier than sole proprietors to borrow money from banks and other financial institutions. As there is a consideration of a corporation to be a distinct entity, there must be a separate evaluation of its creditworthiness. In a sole proprietorship, the creditworthiness of the individual is looked at.
The only thing that can issue stock is a corporation. Compared to other types of businesses, this makes it easier for corporations to get money. Corporations can sell stock to pay off company debt or fund new business ventures.
C corporations can also give out more than one type of stock. A corporation can, for example, give out both common stock and preferred stock. It’s important to note that S corporations don’t have the same advantages. Only one type of stock can be given out by an S corporation.
6. Allows You to Issue Stock Options.
Many business owners choose to pay third parties by giving them stock options or the chance to buy shares at a low price. This is a good idea, especially at the start of a business when money is tight.
You can make a pre-incorporation agreement that says someone will get equity (stock) after the company exists. But it’s much easier to form the company first and then make such offers.
7. You can get funding and build credit for your business.
If an outside investor wants to put money into your business, there needs to be some kind of structure in place to accept the money. Corporations and other investors prefer VC firms due to their flexibility in issuing various types of shares to shareholders.
Even if you don’t want to get money from venture capitalists or angel investors, you may still benefit from a formal business structure. This is because owners of sole proprietorships and partnerships have to sign contracts in their own names.
That means that if you want a loan or a line of credit, you’ll have to use your own credit and assets. However, once a company is incorporated or formed as an LLC, it is given its own credit history.
8. Fiscal Year / Income Splitting.
Most pass-through tax entities, like S Corporations and, by default, LLCs, end their fiscal year on December 31. This is the same date as our own tax year. C Corporations can decide when their fiscal year ends, which lets people decide when their tax years end.
This gives you more ways to manage your money and save money on taxes. For example, you can move income from one entity to another from one tax year to the next and use your corporation to make your money work better for you. As a shareholder in a company whose personal tax year ends on December 31 and whose fiscal year ends on March 31, you can split your personal income into 2 calendar years.
If you have $100,000 left in the corporation before the end of its tax year, you can pay yourself $50,000 in December and $50,000 in January. This could keep you in a lower personal tax bracket, so you pay fewer taxes. You can only do this if you can set the end of the fiscal year for your business.
The total payment of $100,000 to you is a tax break for the company. There are other benefits to this as well. If you have more than one corporation, you can pay profits to a second corporation. As management fees and rolling those profits into another corporation with a different fiscal year-end date is an even better financial management tool.
If you want to use this method, you should talk to a tax expert about “controlled group” issues. When it comes to this, corporations are the most flexible. Pass-through tax entities can set a fiscal year-end date very rarely, but if they do, it’s almost impossible to get it passed. In contrast, corporations can set and change their year-end dates whenever they want.
9. Central Management and Corporate Structure.
The corporate structure is by far the most formal of the options, and it also has the best way to manage the business. A board of directors is chosen by the business’s owners or shareholders.
The board is chosen by the shareholders and re-elected every year. Its job is to carry out what the shareholders want. The board of directors will choose and hire the corporate officers. These are the people who carry out corporate policies and run the business on a day-to-day basis.