Anyone who operates a business has likely considered incorporating at some point. Without doubt, the “entity selection” process is an important aspect for any business owner to learn about and make a well-educated decision. Incorporating does more than simply add an “Inc.” of “LLC” after a business name. Granted, vendors, would-be creditors and customers are perhaps more drawn to interacting with an incorporated company rather than just an individual. However, there are important legal and practical advantages and disadvantages to examine in determining whether incorporation is right for you.
In our opinion, the most important benefit of incorporating is asset protection through limited liability. The “corporate shield” protects personal assets from being exposed to claims against the business. Indeed, a corporation can own property, carry on business, incur liabilities and even bring suit or be sued. For instance, if a corporation incurs debt, then its creditors may only seek recourse from corporate assets. This is in stark contrast to sole proprietorships or unincorporated partnerships who face unlimited liability to both business and personal assets (read: their homes, vehicles, securities, bank accounts, etc. are at risk). Of note, corporate formalities must be followed for this limited liability to stay in effect.
Another advantage to incorporation is the entity will remain in existence in perpetuity. That means a protected corporate name will exist so long as all corporate procedures are followed (e.g., paying the annual registration with the Secretary of State). This also means with a carefully considered shareholder or buy/sell agreement, an entity can remain in the name of those designated by the originators. This often results in shareholders avoiding many unnecessary legal entanglements that stem from non-corporate business structures.
Incorporation also offers tremendous tax benefits. For instance, an LLC is taxed at the same rate as a sole proprietor but still affords limited asset exposure. However, an LLC can also elect to be taxed as a corporation if this is more advantageous. Most LLCs we create elect Subchapter S tax status to avoid double taxation. As a practical and intangible benefit, many tax professionals believe the IRS is less likely to audit corporate filings than those of a sole proprietorship. Owners are also free to lease certain assets to the corporation, such as a building or vehicle, and deduct expenses like depreciation, while in turn, the corporation can deduct lease payments as a business expense.
Incorporating does not come free of all hassle, unfortunately. Entity holders are responsible for paying corporate taxes and filing an additional tax return. This likely will result in additional accounting fees. Indeed, incorporating itself costs money, as does paying annual fees. Moreover, incorporating and maintaining corporate status results in increased paper work in the form of minutes books and corporate meetings. Another significant disadvantage is that if the corporate formalities are not followed, a shareholder can be held personally liable should a creditor or claimant “pierce the corporate veil”. Incorporation is an important decision that should not be taken lightly. It is imperative that professional advice is obtained and vital for a young business to start out with the proper legal foundation. The Law Office of William Patrick Lee, P.C. is fluent in business formation and works with a wide array of companies to develop a formation scheme that best suits the particular situation.