Why Incorporating is Smart Business

on March 8, 2017

Some business owners who run their businesses as basic partnerships have been asking me: do I need to incorporate? The answer is yes. Now. Yesterday is even better.

There are many reasons for this – people will take your business more seriously with an “inc.” behind its name, getting business credit will be easier, there are tax savings to be had, and getting investors will be easier, too.

But far and away, the best thing about forming your business as a corporation is that it limits your personal liability, which is not true for partnerships and sole proprietorships. A corporation can create a firewall between you and your business. Business debts remain business debts and not personal debts.

For example, say that you own an auto repair business and that one of your employees negligently installs new brakes on a customer’s car. One day, while driving down the freeway, your customer’s brakes fail, causing a three-car accident, including several personal injuries. If your business is not set up as a corporation, the injured parties could (and would) come after you personally. This means that you could lose your house, your business, your cars, everything. But that unenviable fate would not be yours if you had incorporated. Creditors are limited to the assets of the corporation for payment and may not collect directly from the shareholders.

So yes, incorporating is one of the smartest things you can do in business.

That said, there are several different sorts of corps to choose from, and that then begs the question: Which type of is right for you? Let’s see:

The Limited Liability Company: Like a corporation, an LLC provides the limited personal liability that is so attractive, along with being a separate legal entity that can sue and be sued, as well as being an entity that can buy and own property in its own name. Those are all nice factors. But what is also nice about an LLC, and why so many entrepreneurs like them, is that they are more casual than a corporation in terms of nuts-and-bolts. It might help to think of an LLC as a partnership where the members have limited liability.

Closely held corporations: Allowed in some states, a ‘closed corporation’ (or ‘privately held corporation’) is one whose shares are owned by only a few shareholders. Although there is no specific number, the corporate Mecca of Delaware is a good example. Delaware law states that a closed corporation cannot have more than 30 shareholders. Less than 15 is more typical (it depends on the state.) The purpose of a closed corporation is to keep ownership and control within a small group of shareholders who have the same goals.

S and C Corporations: S and C corps are the sorts of corporations people generally think of when they think about incorporating. Although lumped together under the general heading “corporation”, S and C corporations are distinctly different, serving different purposes.

S corporations are intended for smaller businesses and are a very common legal structure for many small businesses. Like an LLC, S corps are informal enough to allow you to run your business like a sole proprietorship or partnership, while still giving you the protection of the corporate shield (aka, limited personal liability.)

C corporations (S and C are tax code names) are your basic, standard issue, large corporations. Starbucks and Walmart are C corporations. The distinguishing characteristic, and the reason you might want to pick this entity, is that shares of its stock are easily transferred. The bad news about C corps is with regard to taxation. They are taxed twice: Once when profits are realized, and a second time when those profits are passed onto the shareholders.

So one advantage S corporation have is that they avoid the double taxation whammy. Profits are only taxed once, and in fact, S corps pay no corporate tax at all. Instead, its shareholders report company profits and losses on their personal tax returns.

So, which is best for you? If you hope to create a big business (one that is publicly traded) you will want to choose a C Corp because shares of its stock are most easily bought and sold. While you might like the idea of having an S corporation for tax reasons, they are limited to no more than 100 shareholders, all of who must be individuals. LLC’s may even trump S Corps since they have no limit on the number of shareholders, and those shareholders can be corporations and partnerships.

Generally speaking, LLCs and S Corps are best for smaller start-ups and C corps are best for larger ones.

© 2017, The Strauss Group, Inc.