Forming an LLC or incorporating a business can be a relatively quick and easy process. And it’s an undeniably critical step to protecting one’s personal assets from any liability of the company. However, while incorporating may be straightforward, small business owners often make a few common mistakes that can have a significant impact on their business. Are you guilty as well?
Mistake 1: Choosing the wrong business entity
The three most common types of business structures in the U.S. are the LLC (Limited Liability Company), S Corporation, and C Corporation. Choosing the right business structure can affect the amount of taxes you pay and how much paperwork you need to deal with.
The LLC is great for small businesses that want liability protection, but prefer minimal formality and paperwork. The S Corporation is a pass-through entity for federal taxes (like the LLC) and is great for small businesses that can qualify. Lastly, the C Corporation files its own tax report and should be selected by those companies that plan to reinvest profits back into the company or seek funding from a VC. So what are some of the mistakes made when selecting a business structure?
- A freelance graphic designer forms a C Corporation and finds herself paying a significant portion of her income due to ‘double taxation’; her CPA advises her to elect for pass-through S-Corp treatment for next year.
- Two partners form an S Corporation for their landscaping business and soon realize they must share in the income in direct proportion to their ownership (at least when it comes to tax reporting), even though they’ve actually arranged to allocate the profits 75-25 this year. They should have formed an LLC instead where they can have more flexibility in terms of dividing the profits.
Mistake 2: Incorporating in Delaware or Nevada
Delaware and Nevada are hot states for incorporation, and for good reason. Delaware offers some of the most developed, flexible, and pro-business statutes in the country. And Nevada is increasingly becoming a popular choice for businesses due to its low filing fees, as well as the lack of state corporate income, franchise, and personal income taxes. However, if your small business has less than five shareholders, it’s best to incorporate in the state where your business has a physical presence. Otherwise, you’ll be dealing with too many hassles and costs of operating “out of state” including: difficulties opening a business bank account, having to appoint a registered agent, and fees for operating as a ‘foreign entity’ in your own state.
Mistake 3: Hiring a lawyer to Incorporate Your Business or Form an LLC
You don’t actually need to hire a lawyer to form an LLC or Corporation. If you’ve got a straightforward situation, you can use a legal document filing service to represent yourself to create a business entity. Of course, if you have a particularly complex partnership or financial situation, you should seek the counsel of an attorney.
Mistake 4: Not staying compliant
Your obligations aren’t over once your applications are in and your LLC or Corporation is formed. Keeping your LLC or Corporation in compliance is absolutely critical, and it’s a never-ending job. If a plaintiff shows that you have not maintained your LLC/corporation to the letter of the law, your ‘corporate shield’ can be pierced and your personal assets are vulnerable. So how do you make sure your corporation stays compliant?
- Keep your personal funds separate from those of the business (no commingling: this means keeping a separate bank account and credit card)
- Send in your Annual Statement/Annual Report on time, as required by your state of incorporation
- File for foreign qualification if you’re operating in any state(s) other than your state of incorporation
- Keep the state up to date with any key changes to your business by sending in Articles of Amendment
- Don’t engage in any form of fraud
Mistake 5: Not incorporating at all
Of course, the biggest mistake of all is never forming an LLC or Corporation in the first place and putting your personal assets (savings account, retirement fund) at risk. Even if you’re putting in 80-hour weeks to drum up new business, make some time this year to incorporate. You’ll be able to scale far more smoothly and securely for years to come.
*Original content written by Nellie Akalp for AllBusiness.com: http://www.allbusiness.com/government/public-finance-taxes-taxation/15701813-1.html