Incorporating is a big step for your small business, and the process can be a bit overwhelming. Which corporate structure should you choose? What paperwork do you need to file? Are there any legal issues, or should you discuss them with a lawyer? But don’t panic. Incorporating should be an exciting step in your professional career, and it doesn’t have to be a headache.
Here’s everything you need to know to incorporate your business.
What Does it Mean to ‘Incorporate your Business’
Incorporation simply means registering your business as a corporation, which is a new and separate legal entity. Instead of the business being tied to its one or two owners and employees, a corporation has a different ownership structure.
Shareholders are the individuals who purchase stock, or partial ownership, in the corporation. They also elect a board of directors. The board is responsible for setting policy, management structure, and appointing the officers. Finally, the officers are those who actually run the company on a daily basis. Officers include the CEO, CFO, CMO, secretaries, and so on.
This change signifies a level of maturity and organization that does not always come across when you are operating as a freelancer, sole proprietorship, or partnership. Incorporating makes your business more enticing, not only for customers but also for investors, creditors, and vendors. There are other benefits to incorporating as well, including liability protection and tax advantages.
How Does Incorporation Work?
Incorporating is not nearly as complicated as it might initially seem. Once you decide incorporation is the right step for your company, you can choose a name, the state you want to incorporate in and start drafting the required documents.
You will also need to select the appropriate corporate structure:
- LLC: An LLC is a limited liability company. These are popular among small businesses and sole proprietors. They offer the advantages of the corporate structure without creating shares and splitting up ownership.
- C-Corp: Corporations can’t be owned by shareholders instead of individuals or businesses. However, individuals and businesses can become shareholders. C-Corp is the most popular type of corporation. The company’s profits are taxed once, and then dividends to shareholders are taxed on personal tax returns as well.
- S-Corp: An S-Corp is very similar to a C-Corp with one key difference. Profits and losses “pass-through” to the owner and are taxed at the personal income tax rate. A C-Corp can become an S-Corp at any time and vice versa. However, an S-Corp is limited to 100 shareholders.
It’s important to note that the incorporation process is regulated at the state level, and cities might have added requirements. You should consult your secretary of state office and discuss your options with a lawyer to make sure you’re complying with local regulations.
Do you need to Incorporate your Business?
Incorporating isn’t necessarily for everyone. But it is essential for those who want to take their business to the next level and set it up for long-term success. Incorporating offers a number of key legal and financial benefits.
The most important benefit that incorporating your business offers is personal asset protection. A sole proprietor or general partner to an unincorporated business has unlimited liability for any of the debts and obligations of the business. So, if the business runs into financial troubles and defaults on loans, the owner’s personal assets – like their savings, house, or car – could be reached to pay off creditors.
Incorporating puts owners and managers in a position of limited liability. The business exists as a separate legal entity, so any debts and obligations are unique to the company. An owner or manager’s personal assets can’t be used to fulfill any of those obligations.
Incorporating comes with several other key benefits:
- Tax advantages: Different corporate structures offer different tax advantages. Your company can elect to be taxed as a corporation so that you don’t have to report profit and loss on your own income tax return. Filing as an S-Corp offers the ability to avoid double taxation of certain profits and dividends as well.
- Deductible expenses: Corporations can deduct business expenses before distributing income or dividends to its owner.
- Credibility and maturity: Incorporating adds a degree of legitimacy to your business, making it more attractive to customers, creditors, investors, and vendors.
- Name protection: Even though you can only incorporate in one state, most other states will recognize your company’s existence and will not let other entities copy your business.
- Longevity: The company exists independently of any owners or managers. So, even if the initial owner were to die or step away from their position, the company would continue to exist.
Should You Incorporate or Start an LLC?
Deciding between an LLC, C-Corp, and an S-Corp is about what’s right for you and your business. Each option gives the owners limited liability and various tax and financial advantages. The primary difference between an LLC and a corporation is the ownership structure.
An LLC is very similar to a sole proprietorship or a partnership. Rather than issuing shares of stock, individuals, and companies retain ownership of the LLC. This is the popular choice for sole proprietors and other small businesses.
Larger companies often choose to incorporate. This requires the company to issue shares of stock. This might split up ownership, it comes with a tax advantage. Corporations are typically taxed at a lower rate than individuals.
How to Incorporate Your Business
1. Decide to incorporate
Before you decide to incorporate, make sure you’re fully aware of all the financial, legal, and managerial advantages of incorporating. Once you decide that incorporating is right for you, you can choose the structure that best suits your needs: LLC, S-Corp, or a C-Corp.
2. Choose the state where you want to incorporate
Picking the state to incorporate or establish an LLC should not be a confusing step in the process. Many people think that incorporating in certain states is beneficial for tax or other financial reasons. While true, it is not always easy or cheap to incorporate in a state you don’t actually operate in or have a physical presence in.
Most corporations and LLCs are set up in the state where they primarily operate. This avoids any unnecessary confusion, typically costs less, and avoids franchise taxes and annual reporting in multiple states. Once your corporation is established in one state, you can then register to do business in other states.
For businesses that do operate in multiple states or are located outside the U.S., selecting the state to incorporate is a bit more serious. Consider registering in the state where you’ll be doing most of your business otherwise, consult a tax attorney to see if there is another state that might be a better fit.
3. Choose and reserve a name for your business
You may already have a name picked out, maybe the name you have been operating under. But, you need to make sure that the name is unique. Your secretary of state won’t allow two corporations to use the same name. This wouldn’t only create confusion in the market, but it would also tread too close to trademark infringement.
Most states offer an online directory where you can search your name to see if it is taken or if there is something too similar. Once you settle on an available name, you might be able to reserve it for 60 to 120 days while you finish incorporating. Remember, you’ll also need to add Inc., Corp., or Co. to the end of your name to signify its new status.
4. Hire a registered agent
A registered agent is a person or other company in the state where you incorporate that will accept official mail on your new company’s behalf. This can be one of the directors, officers, or employees of the company. An attorney for the business can also serve as the registered agent so long as they have an office in that state as well. States make this a requirement so they know where to send service of process if your company is sued and other official correspondence.
5. Prepare and File Articles of Incorporation with the State
The Articles of Incorporation (also called a corporate charter or certificate of incorporation) is a required document to create a corporation. The Articles contain the business’s essential information like the name, office location, registered agent, number and type of shares, and name of the incorporator.
Some states will ask for added information including:
- A mission statement or an explanation of the company’s purpose
- Contact information for the Board of Directors
- Contact information for the company’s officers
Most states have templates ready to go on the secretary of state’s website. Otherwise, there are other online sources full of templates that you can use as well.
6. Place your order for incorporation
Once the Articles of Incorporation are drafted, you can file them with the state. The filing fee varies from state to state, ranging from $100 to $500. You can file by going to your state’s secretary of state website and following the steps there. You could also consult an incorporation service such as LegalZoom or an attorney who can help you through the process.
Next Steps After Incorporation
After incorporating, the work is not done. There are still steps you need to take to make sure your company is being run properly. These so-called “corporate formalities” include:
- Apply for an employer identification number (EIN)
- Apply for the appropriate licenses and permits in your state
- Draft corporate bylaws
- Start a new corporate record book
- Open a business bank account
- Do not comingle the company’s funds with personal funds
- Hold your first corporate meeting
Make sure to check with your state to see if they have any additional requirements. Not following the state rules of incorporation puts your business at risk. It might also jeopardize the limited liability given to owners and managers since the company is not being run properly. Follow these ‘corporate formalities’ to make sure everything is above board.
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Frequently Asked Questions
How much money does it cost to incorporate?
Incorporating costs a couple of hundred dollars depending on where you incorporate. After filing, you can be approved within a matter of weeks.
When should you incorporate?
There is not necessarily a “best” or “worst” time to consider incorporating. It depends on the business’s financial situation and your goals with the company. If you plan to operate long-term, there are advantages to incorporating sooner. But, if you’re not sure about your own goals and the company’s longevity, you might want to consider operating as a sole proprietorship before incorporating.
What does it mean for a business to be incorporated?
A business that is incorporated is its own separate legal entity. This means that it exists and operates independently of any of its owners, managers, directors, or officers. The corporation has its own legal and contractual obligations, credit history, and finances.