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The advantages to incorporation for even small businesses make the effort worthwhile. The main pluses are the ability to tax-shift, raise funds, and protection from liability.
As a corporation, businesses will pay half of social security taxes directly from the corporate account – instead of paying the entire 15% as self employment taxes. There are also opportunities to shield income from taxes through a 401k plan (or other retirement mechanism), a healthcare plan, life insurance and charitable contributions. While some of these mechanisms have parallels in non-incorporated structures, a corporation has the advantage of structuring benefits through standard organizational plans.
The ability to raise capital by leveraging the inherent value of a business shouldn’t be underestimated. The historical purpose of a corporation was to form an entity with distributed ownership. In a sense, it is like splitting up the worth of an enterprise into many pieces. Control can be retained by holding on to the majority of shares, while investment capital can be raised by selling other shares.
Investors may be keen to take risks with an offer of partial ownership. Stock then has a ‘real’ or immediate value as well as a potential value. Many private equity firms will only invest when their money can be backed up by holding stock. This avenue isn’t available to non-corporations.
Often touted as the main advantage of a corporation, liability to the owners is reduced because the corporation acts as a legal entity. Lawsuits may only be able to attack the assets of the corporation, rather than the personal assets of stockholders. This includes loans taken out in the corporate name and product lawsuits.
The Basics of Incorporation
Incorporating is a State level activity and the nuances vary by State. There are, however, some common elements:
- Select and research a name to incorporate under. Every corporation has a unique legal name in the State of incorporation. One requirement is to include “Inc.” or “Corp.” in all formal correspondence and advertising – this varies slightly by State.
- Appoint directors of the corporation. These do not have to be shareholders, and the required positions also vary by State and type of corporation. In smaller companies, the directors are usually the owners of the business.
- File articles of incorporation with State authorities. Which State a company is incorporated in will determine the actual forms, and some States are ‘corporate friendly’. It helps to research options on which State to incorporate in – for instance, a State with lenient corporate taxation might be a possibility. The fee for incorporation varies by State, but averages about $500.
- Draw up corporate bylaws. This will be a legal outline of how the corporation is run. Great care must be taken to cover all the bases in the bylaws – many legal battles can be avoided when the ruling document is clear and addresses common issues.
- Hold the initial meeting of the board of directors. This is a formal meeting with minutes recorded and allows initial votes on the bylaws.
- Get any required licenses or permits to operate in the company’s name.
- Issue stock certificates to corporate shareholders.
- Publish required notifications in local media (usually the legal section of the newspaper).
Does Incorporation Require Professional Help?
No. Individuals and partners incorporate quite regularly without any professional guidance at all. It is similar to filing personal taxes. The process isn’t easy, but it’s doable. Having a professional involved (or getting straightforward advice from a service) helps make sure that all the details get addressed.
This is probably most important for a first timer or someone converting a sole proprietorship to a corporation. Sometimes, the process can seem cumbersome and difficult to understand. There is legal terminology to grasp and several hurdles to jump. A main consideration is the corporate calendar and tax cycle – a corporation is treated as a separate entity under tax laws and the these forms by themselves can be quite intimidating.
There is nothing to prevent someone from exploring a do-it-yourself approach and then, if necessary, getting professional help. A lawyer or CPA isn’t required, but these are the top tier professionals in this area. Of course, fees increase dramatically, depending on who is hired and how involved they become in the process. A mid-level solution is to do the work as an individual and then hire a pro to check everything and make suggestions.
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