Pros and Cons of Incorporating Your Business
Sept. 17, 2002 Whether or not you should incorporate your business depends on your type of business and your specific needs. According to the Oklahoma Society of CPAs, you might consider incorporating your business if you are interested in limiting shareholder liability, securing certain tax benefits or obtaining financing.
OSCPA provided a list of pros and cons for you to consider.
Advantages of incorporating:
Limited Liability. Limiting liability often is the most important reason for small business owners to incorporate. Assuming that all the legal requirements for establishing and maintaining a corporation have been met, a corporation is treated as a separate legal entity and, as such, incurs business debts or liabilities on its own behalf. Typically, this means that, as a shareholder, you are not personally held liable for the debts and obligations of the corporation if the company cannot pay its debts or is sued. By contrast, a proprietor’s or partner’s home, savings and other assets can be seized to pay the debts of the business.
Tax Benefits. Incorporating has a number of tax advantages. First, corporations are taxed at a lower rate than individuals. In a C corporation, the first $50,000 of federal taxable income is taxed at 15 percent, significantly less than the marginal individual tax bracket of up to 27 percent. Corporations also have greater flexibility in deducting fringe benefits and other expenses. The cost of salaries, bonuses, education benefits and dependent care assistance are among the benefits deductible by corporations.
In addition, items that are only partially deductible by a sole proprietor may be fully deductible in a corporation. For example, while the health insurance deduction for sole proprietors currently is limited to 60 percent of the premium cost, corporations can deduct 100 percent of health insurance benefits paid on behalf of an owner-employee. Finally, retirement plans set up within a corporation may provide additional tax benefits.
Self-proprietors pay self-employment taxes (Social Security, Medicare, Workers Compensation) of 15.3 percent on all income earned in the business. In a corporation, only salaries are subject to these taxes. This means a sole proprietor who nets $50,000 in taxable income from the business will pay income and self-employment taxes on the full $50,000. The owner of a corporation, on the other hand, could lower his or her tax bill by choosing to pay himself $40,000 in salary and leaving $10,000 in the company’s coffers.
Access to Capital. Incorporating your business also can result in greater flexibility in raising capital. Instead of borrowing money and making interest payments, you can raise capital through the sale of stock and other equity interests. Although this involves giving up some ownership of the company, shares offered to investors can be tailored so that you maintain control of the company.
Continuous Life. A corporation is the most enduring legal business structure. Unlike a proprietorship or partnership, a company does not cease to exist upon the death of its owner(s). If an owner of a corporation dies or wishes to sell his or her interest, the corporation can continue to exist and do business.
Disadvantages of incorporation:
Double taxation. The primary disadvantage to a corporation is double taxation. When the profits of a corporation are distributed to shareholders as dividends, they are taxed twice - first as income to the corporation, and then as income to the shareholders. It is possible to avoid this double taxation by electing S corporation status.
Complexities. Forming and maintaining a corporation in good standing requires a significant amount of paperwork, recordkeeping and accounting. When a corporation is first established, articles of incorporation must be filed. While each state has its own requirements on what constitutes “in good standing,” typically, corporations must hold and record minutes of annual shareholder and director meetings and document major decisions by directors. Also, a corporation needs to keep excellent financial records to facilitate the filing of more complicated tax returns.
Seek Professional Advice. Incorporating your business is not a decision to be taken lightly or without the proper analysis of your company’s circumstances. A CPA can help you determine whether incorporating makes good business sense or whether you should consider another type of entity such as a Limited Liability Company (LLC) or an S Corporation. Like a corporation, these two entities have advantages and disadvantages, so it’s a good idea to learn about all three before deciding what legal form your business should take.
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