What Are the Pros and Cons of Incorporating Your Business?
November 5, 2022
peakreliance
Accounting, CPA, Taxes
Incorporating a business at some point is integral for its further growth and as the founders, business owners are often skeptical about the whole idea of turning their start-up into a corporation.
In this blog we are aiming to help you make an informed decisions about incorporating your business by helping you figure out if it’s the right time to do so or not. But first, let’s elaborate a bit more on what it means to ‘incorporate a business’.
Incorporating means to take the legal ownership and turning the business into a formal company recognized by the related state of incorporation. In technical terms, it is turning your sole proprietorship or general partnership into legally and formally recognized corporation.
A corporation is an entity in itself and separate from its owners thus having its own assets and liabilities separate from the founders. There are many pros and cons when taking this decision but what you need to consider is that if the move is right for you and your business.
Pros of Incorporation
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Independent legal entity
Perhaps one of the biggest benefits to becoming an incorporated company is its legal separation from its founders. As long as the business is not a corporation, the business and the owner is the same legal entity, so if anything goes wrong or if the business owes money, the owners will be personally liable for it. With a corporation, the risk stays with the company as an independent entity, and to the maximum extent, the directors aren’t liable.
The best example of this is, if a customer or client took the business to court, with a sole proprietorship, it would be the owners’ responsibility, whereas with a limited company it would be the company itself.
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Tax
Tax rules are applied differently on start-ups and sole traders and on corporations. For a running sole trader business where the generated income is beginning to reach new highs, your accountant may suggest you to become a registered company to take advantage of your personal tax savings from the existing tax laws for corporations. While as a sole trader your profits are seen as your total income and you are taxed on it’s basis, a limited company is completely independent and the director is taxed as an employee eliminating all miscellaneous liabilities.
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Raising Capital through Shares
A corporation has the advantage of selling its shares. If you’re looking to expand or branch out into a new area, or new to raise additional capital, you can sell the company’s shares to friends, family or other interested investors to help your business raise money.
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Reliability
A start-up can be set up in no time at all, and there is no solid proof that they are even a legitimate or long-lasting business. Of course, this doesn’t mean that start-ups or sole traders do not qualify as businesses but when comparing a corporation with a business that has yet to be incorporated, the difference will definitely remain. The credibility of a state recognized business will always be more than the one not on this position. On that basis, some people and clients place more trust in limited companies. So incorporating your business will increase its standing and ultimately will ensure profitability in the future by eliminating doubts about the trustworthiness.
Cons of Incorporation
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Additional complicated paperwork
Incorporating your business can be both a time-consuming and a complex process due to all of the technical and elaborated paperwork involved. To maintain a corporation, you need to keep detailed records of your articles of incorporation and bylaws, including information about all meetings held as well as a register of directors, employees, and shareholders.
In addition to tracking meetings and other activities, it is essential to keep organized records of transactions. You need up-to-date records of each and every financial transaction so the corporation can file income tax returns correctly.
Since, each state also has its own guidelines on recordkeeping requirements for incorporated businesses, you must also adhere to the rules put forward by your state.
Hiring an accountant or a CPA can help you a great deal in this case.
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Cost of the process
One shortcoming of incorporating a business are the expenses that come with it. Because a corporation has a more complex structure than other forms of businesses, they generally tend to be more expensive to set up.
In order to form a corporation, you have to pay certain fees and after you establish your corporation these fees continue. They are ongoing and can be costly for small businesses who aren’t generating enough income. For instance, some states impose long term fees on corporations. Here are some other fees that you may have to pay:
- Set-up cost
- Legal fees
- Accountant fees
- State fees
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Double taxation
Another drawback of incorporating your business is double taxation. Double taxation is when a corporation has to pay the same amount of income tax twice on the same income. For a corporation, this means being taxed on both personal and business levels.
Corporations always pay taxes on their annual/yearly earnings. When a corporation pays dividends to its shareholders, the dividends have tax liabilities as well. Shareholders who receive these dividends must pay taxes on them too.
Business structures other than a legal company can dodge double taxation with pass-through taxation. Pass-through taxation refers to when taxes pass through the business and onto the owners or individuals simultaneously.
If you want to sidestep double taxation altogether, you may want to establish an S corporation or consider all possible outcomes and be prepared of all before incorporating your business.
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Accounting, cpa, Incorporating a business, Online CPA, pros and cons of incorporation, tax
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