Should You Incorporate your Business

The question of whether or not to incorporate your business is not always easy, and a variety of practical, financial, and tax considerations which come into play. Once you incorporate you will have to operate your business separately from your personal affairs. You will need to observe the required formalities for the form of incorporation you choose, including holding all required meetings, filing annual reports, and possibly filing a separate tax return for your incorporated business.

The decision to incorporate is best made after consulting your accountant, and possibly also a small business lawyer.

Before incorporating, a business must consider if it would be better off as a sole proprietorship or partnership, or if they should form as a limited liability company, as opposed to becoming a traditional corporation.

Factors to Consider Before Incorporating

Considerations for those who are weighing whether or not to incorporate include :

  • Limited Liability: Is your business of a type that would benefit from the limited liability afforded to a corporation, so as to shield your personal assets from corporate creditors or liabilities?

  • Costs and Fees: Will the cost of incorporation, payment of annual franchise fees, and of creating an appropriate accounting system and maintaining corporate bank accounts, exceed the benefit of incorporation?

  • Complexity: Will the added burden of maintaining the corporate structure, implementing proper accounting systems and procedures, and conducting annual meetings and filing annual reports with the state, impose an undue burden on your business?

  • Taxation: Will you and your business have a reduced or increased tax burden if you incorporate, or will it remain unchanged? If you incorporate, will you benefit from the pass-through taxation of an S Corporation or through paying corporate taxes as a C Corporation?

  • Fringe Benefit Packages: Will you benefit from the deductibility of the fringe benefit package offered to shareholder employees, which may be enjoyed by C Corporations, as opposed to having those fringe benefits taxed as income to the employee?

  • Investors and Employees: Will the greater flexibility offered through the issuance of stock, and the possibility of offering stock options, help attract investors and help attract and retain key employees?

  • Structure: Will your business benefit from the structure required of corporations, with the various rights and duties of corporate stockholders, directors, and officers?

  • Succession Planning: Will the fact that the corporate structure continues indefinitely, with transfer of ownership possible through the sale or transfer of stock, assist with succession planning or your estate planning goals?

  • Transfer of Shares: Will your business benefit from the ability to transfer shares? Can you adequately control any risk of shares being transferred to or inherited by undesirable parties by implementing a buy-sell agreement restricting transfer of shares?

  • Public Records: Will you be required to disclose information into public records, such as the identity of your corporation's directors, which you would prefer remain confidential?

S Corporations vs. C Corporations

By default, a corporation formed in the United States is classified by the IRS as a C corporation. The corporation may elect to instead be classified as an S corporation.

For most smaller corporations the biggest difference between status as a C Corporation and Status as an S Corporation relates to the taxation of profits. A C Corporation can retain its profits which are taxed at the corporate tax rate. An S corporation has pass-through taxation, meaning that profits are taxed as income on the shareholders' personal tax returns.

Even if attracted to pass-through taxation, some corporations are ineligible for S status, due to such factors as foreign ownership, the number of shareholders, or the desire to issue multiple classes of stock.

Should You Become a Corporation or LLC

Many businesses find that they receive adequate protections from liability by forming as limited liability companies, while also avoiding much of the cost and complexity of forming as a traditional corporation.

Unless there are obvious reasons why forming as an LLC would not serve your business needs, you should consider and discuss this option with your lawyer and financial advisers before choosing the corporate form for your business.

Copyright © 2004 Aaron Larson, All rights reserved. No portion of this article may be reproduced without the express written permission of the copyright holder. If you use a quotation, excerpt or paraphrase of this article, except as otherwise authorized in writing by the author of the article you must cite this article as a source for your work and include a link back to the original article from any online materials that incorporate or are derived from the content of this article.

This article was last reviewed or amended on Apr 7, 2018.