Business Formation and Incorporation
What does it mean to incorporate?
Incorporating a business means turning your sole proprietorship or general partnership into a company formally recognized by your state of incorporation. When a company incorporates, it becomes its own legal business structure set apart from the individuals who founded the business. Through incorporation, the company's owner or owners create a separate legal entity to transact business. This new business entity corporation or limited liability company (LLC) transforms the way the business is seen through the eyes of the law and often has more credibility with potential customers, vendors and employees.
Here are some of the steps included in the process:
- Determine where you want to incorporate.
- Decide which business type is best for your business and goals. Consult with an attorney or accountant.
- Determine who the directors of the corporation or who the members/managers of the LLC will be.
- Select a registered agent. Your registered agent must be listed on your Articles of Incorporation or Articles of Organization. The registered agent is appointed by you to receive important legal and tax documents on behalf of your business and forward them to you.
- Prepare and file the Articles of Incorporation or Articles of Organization per instructions from the Secretary of State's office.
Limited Liability Company or LLC
LLCs shield the owners, who are called members, from being personally liable for actions of the LLC. LLCs also provide flexibility in management and offer the benefit of pass-through taxation which means that the profits and losses of the business pass through to its owners, who report them on their personal tax returns. Pass-through taxation is among the reasons why LLCs are significantly easier to run compared to a corporation.
Why choose an LLC
Consider forming an LLC if you are fearful of personal risks to lawsuits arising from your business. For example, if you decide to open a storefront business that deals directly with the public, you may fret that your commercial liability insurance won’t fully cover your personal assets from potential slip-and-fall lawsuits or claims by your vendors for unpaid debts. Running your business as an LLC may ease your mind because it instantly offers you an additional layer of security against these and other possible claims against your business.
The S corporation business entity type is a corporation that comes with a special advantage: it has the limited liability of a corporation, but without the "double taxation" of income passed through to the shareholders. Prior to the acceptance of the LLC, the S corporation was the best vehicle to shield the owners while avoiding double taxation. The "S corporation advantage" allows a business owner to use the business losses—such as those incurred during the startup phase—on their personal returns as deductions. S corporations can also provide savings for their owners on self-employment or Social Security/Medicare taxes along with the FICA (Federal Insurance Contributions Act) tax.
Why choose an S corporation?
An S corporation allows the owners to offset non-business income with losses from the business, unlike a C corporation which is a completely separate tax entity. When compared to an LLC, the S corporation enables an owner to characterize a portion of income as “dividend,” rather than “earnings” that are subject to employment taxes.
C corporations are the most common type of corporation. They offer more flexibility than S corporations relative to the number of owners (shareholders) they can have and who can be an owner. Because of a pronounced ability to deduct employee benefits, C corporations are often preferred by developing businesses.
Why choose an C corporation?
C corporations offer more flexibility than S corporations when it comes to the number of owners (shareholders) they can have as well as who can be an owner. Plus, the owners can hold different types of stock interests (such as preferred versus common stock.) This is one reason why venture capitalists choose C corporations when they offer funding to a business. Investors are drawn with the prospect of dividends if the corporation makes a profit. A C corporation can also retain and accumulate earnings (within reasonable limits) from year to year.
A nonprofit corporation is one that is formed for purposes other than making a profit. Nonprofit organizations come in many forms. Examples include churches, soup kitchens and hospitals. Forming a nonprofit corporation helps you avoid personal liability for the debts of your organization. The principal advantage to nonprofit status for an organization is that it will be qualified to receive both private and public grants.
Why form a non-profit?
While incorporating your not-for-profit venture is not a requirement, it lends more credibility to your organization. Also, in order to become tax-exempt, you must incorporate and also file Form 1023 with the Internal Revenue Service. A few states require a separate file for state tax-exempt status as well.