6 Advantages of Forming A Corporation

Choosing the right business structure can make or break your business.

The U.S. Bureau of Labor Statistics (BLS) reports that around 20% of new businesses fail within their first two years, 45% within the first five years, and 65% within the first decade. Only 25% of new businesses manage to survive for 15 years or more.

There are many reasons a business might fail—more market research, issues with business planning, more funding, better marketing, and expanding too quickly.

Another reason these businesses don’t last is that entrepreneurs make the wrong choice when the business is set up initially. Specifically, we’re talking about choosing the type of business entity under which the business falls.

There are several different options in the U.S.A. (sole proprietorship, partnership, limited liability company, or corporation), and each affects tax status, personal liability, and compliance and reporting responsibilities.

Whether you plan to open a small business or a worldwide enterprise, you can avoid becoming another statistic by making the right choice.

Incorporating your business offers numerous benefits, from protecting your personal assets to securing tax advantages.

In this blog, we’ve got lots to cover:

• What it means to incorporate your business
• The advantages (and disadvantages) of incorporating
• The steps involved in getting your business incorporated
• The four types of corporations and their pros and cons
• How to decide what kind of corporation would be best for your business

Our goal is to help you make an informed decision about incorporating your business so you can get the most out of its many advantages and make your business a real success story.

What Does It Mean to Incorporate Your Business?

Simply put, incorporating a business means forming your company or organization and establishing it as a separate legal entity from yourself.

This separation has significant legal implications:

• Financial Liability: Owners (shareholders) are not personally liable for the corporation's debts or legal obligations. This means that if the corporation faces a lawsuit or bankruptcy, the personal assets of the owners are generally protected.
• Limited Liability Protection: Owners' personal assets are shielded from the corporation's liabilities, reducing personal financial risk.
• Perpetual Existence. The corporation continues to exist even if the original owners leave or pass away, ensuring business continuity.
• Decision-Making Autonomy: The corporation can make decisions, enter into contracts, and own property. This autonomy allows the business to operate and grow without direct interference from individual owners' personal affairs.

Key Steps Involved in Incorporating a Business

1. File Articles of Incorporation: You'll need to file documents with your state's Secretary of State office and pay the filing fee (this varies by state). These documents include details about your business, such as its name, address, purpose, and the number of shares it can issue. Filing can typically be done online or by mail.
2. Establish Corporate Bylaws: Bylaws are the internal rules that govern how your corporation operates. They outline procedures for holding meetings, making decisions, and how profits are distributed. To complete this step, you can consult with a corporate lawyer, or use an online temple (make sure it's intended for your state). This step isn't mandatory in all states. Still, we recommend creating bylaws because they reduce the chance of disputes between shareholders.
3. Appoint a Board of Directors: The board of directors oversees the corporation's activities and makes major decisions. Board members are typically elected by the shareholders and act in the best interests of the corporation.

Key Advantages of Forming a Corporation

According to the U.S. Census Bureau, corporations represent only 18% of all businesses but they generate 82% of total business receipts in the United States. This statistic highlights the financial advantage of forming a corporation, but it goes beyond just money.

We'll dig deeper into each, but at a high level, there are a few of the advantages a corporation can offer:

• Secure Your Assets
• Gain Tax Breaks
• Facilitate Business Growth and Continuity
• Easy Transfer and Access to Capital
• Retirement Planning and Benefits
• Anonymity and Privacy

Secure Your Assets

Incorporating your business provides limited liability protection. This means shareholders are not typically responsible for the corporation's debts and liabilities. This separation protects personal assets such as homes, cars, and savings from business risks.

This protection is not offered to sole proprietorships and partnerships. For example, a sole proprietor facing a lawsuit might have to sell personal property to cover legal costs. A corporation's liabilities are generally limited to the corporation's assets.

Real-World Example:A tech start-up incorporated as a C-corporation faces a lawsuit over patent infringement. Due to the corporate structure, the owner's personal assets remained untouched, and the business settled the lawsuit through its corporate funds. If the same business was a sole proprietorship, the owner might need to liquidate personal assets to cover legal expenses.

Gain Tax Breaks

Corporations have tax advantages that can lead to significant savings and improved financial health for your business.

• Health Insurance Premiums: Corporations can deduct the cost of health insurance premiums for employees and their families.
• Savings on Self-Employment Taxes: Unlike sole proprietors, corporation owners do not pay self-employment taxes on business income.
• Life Insurance Deductions: Corporations can deduct the cost of life insurance premiums for employees, further reducing overall expenses.
• Lowered Tax Rate for High Earners: Corporate tax rates are sometimes lower than individual tax rates, especially for high earners. The Tax Cuts and Jobs Act of 2017 reduced the corporate tax rate to a flat 21%, which would lower a high earner's tax burden. (If your income is over $578,126, your tax rate is 37%.)
• Recent Changes in Tax Legislation: Recent tax reforms, such as the CARES Act, allow corporations to carry back net operating losses from 2018, 2019, and 2020 to the previous five years, potentially leading to tax refunds and financial relief.

Facilitate Business Growth and Continuity

Incorporating your business can help make growing your business easier and help keep it going even without your involvement.

Customers, suppliers, and partners often view incorporated businesses as more stable and trustworthy. This can lead to more opportunities and more favorable terms in business dealings.

Corporations continue to exist even if the original owners leave or die. This ensures business continuity and can attract investors who want long-term stability.

Real-World Example: A small retail business incorporated as an S-corporation to help its expansion plans. Incorporating helped it raise capital through the sale of shares, attract talented employees with stock options, and negotiate better terms with suppliers. Five years later, the business went from a single store to a nationwide chain.

CALLOUT:

“A corporation’s liabilities are generally limited to the corporation’s assets.”

OR

“The greatest upsides to incorporating your business are liability protection, tax advantages, business growth and continuity, better access to capital, retirement planning and benefits, and privacy options.”

Easy Transfer and Access to Capital

Corporations allow for easy transfer of ownership through the sale of stock. Shareholders can buy and sell shares without affecting the corporation's operations, providing flexibility and liquidity.

Issuing stocks helps with raising capital and broadens the ownership base, attracting more investors and financial resources.

Incorporated businesses often find it easier to secure loans compared to sole proprietorships or partnerships because corporations are viewed as more stable and reliable.

Retirement Planning and Benefits

Corporations can establish retirement plans, such as 401(k)s and profit-sharing plans, that benefit both owners and employees. These plans provide tax advantages and help attract and retain top talent.

Corporate retirement plans often have higher contribution limits and more options than individual plans. This allows business owners and employees to save more effectively for retirement while enjoying significant tax benefits.

Anonymity and Privacy

In many states, corporations can be structured so that the identities of shareholders and directors are confidential.

Privacy protection is essential for owners who wish to avoid unwanted attention or avoid potential threats. For example, high-profile entrepreneurs may choose to incorporate to keep their business interests private and secure.

Incorporation laws vary by state, with some offering stronger privacy protections than others. For instance, Delaware, Nevada, and Wyoming are known for strong corporate privacy laws. These states allow for the creation of anonymous corporations. If this is an important consideration for you, consider these states when you incorporate.

These benefits make incorporation an attractive option if you want to secure your assets, optimize your tax situation, and grow your business. Understanding and leveraging these advantages can have a huge impact on your business's trajectory.

Types of Corporations

Once you've decided that incorporating your business is the right move, it's time to choose the type of corporation. Each type of corporation offers unique advantages and disadvantages.

To help you make the right choice, we've created a quick overview of the four different types of corporations:

C Corporations

C corporations, or C-corps, are the most common type of corporation. They are legal entities separate from their owners, providing strong liability protection.

Advantages:

• Limited Liability: Owners are not personally liable for business debts.
• Unlimited Growth Potential: Ability to raise capital through the sale of stock.
• Tax Benefits: Deductible business expenses and benefits.

Disadvantages:

• Double Taxation: Corporate profits are taxed, and shareholders are also taxed on dividends.
• Regulatory Requirements: More complex and costly to set up and maintain compared to other business structures.

S Corporations

S corporations, or S-corps, offer similar liability protection as C-corps but with different tax benefits. They are designed to avoid the double taxation of C-corps.

Advantages:

• Pass-Through Taxation: Profits and losses pass through to shareholders’ personal tax returns, avoiding double taxation.
• Limited Liability: Shareholders are not personally liable for the corporation's debts.

Disadvantages:

• Ownership Restrictions: Limited to 100 shareholders, all of whom must be U.S. citizens or residents.
• Less Flexibility in Profit Distribution: Profits and losses must be allocated according to share ownership.

B Corporations

B corporations, or Benefit corporations, are for-profit entities that include positive social and environmental impacts in their mission.

Advantages:

• Social and Environmental Goals:Legally required to consider the impact of their decisions on society and the environment.
• Attracts Socially Conscious Investors: Can appeal to investors interested in social responsibility.

Disadvantages:

• Additional Reporting Requirements:Must meet higher standards of accountability and transparency.
• Potential for Conflict: Balancing profit goals with social and environmental objectives can be challenging.

Nonprofit Corporations

Nonprofit corporations are established to serve public benefits rather than earning profits for owners.

Advantages:

• Tax-Exempt Status:Exempt from federal income tax and may be eligible for state and local tax exemptions.
• Grant Eligibility: Can apply for grants and receive public and private donations.

Disadvantages:

• Strict Regulations:Must adhere to strict reporting and operational requirements.
• Limited Profit Distribution: Profits cannot be distributed to owners or shareholders.

Still not sure what direction to go? This decision matrix might help choose which type of corporation might be best suited to your business goals and needs:

The type of corporation you choose is a critical decision that can impact your business's success and direction.

C corporations offer strong growth potential and liability protection but come with strict reporting and double taxation. S corporations provide tax advantages with pass-through taxation but have ownership restrictions. B corporations blend profit with social responsibility, attracting socially conscious investors but requiring additional reporting. Nonprofit corporations have tax-exempt status but must adhere to stringent regulations and can't distribute profits.

By understanding these types and their unique advantages and disadvantages, you can make a decision that aligns with your business goals and needs.

Potential Disadvantages of Forming a Corporation

We've shared many of the advantages of forming a corporation. Like most things in life, incorporating is not all positive–it comes with notable drawbacks.

• Double Taxation. C corporations face double taxation (taxed at the 21% corporate tax rate and at the individual level). This can be mitigated by electing S corporation status, which allows for pass-through taxation.
• Ongoing Fees and Administrative Costs. Corporations incur higher ongoing fees and administrative costs compared to other business structures. Strategic planning and budgeting can help manage these expenses.
• Increased Record-Keeping and Regulatory Compliance.Corporations must maintain detailed records and comply with stringent regulations. These obligations often require more time and effort than those of other business types. A professional accountant or legal expert can reduce this workload and keep the business compliant.

You'll notice that even though there are some disadvantages, there are workarounds for each. Strategic planning, electing different corporation types, and consulting with experts can help offset these potential roadblocks.

In short, give these disadvantages some thought, but don't let them discourage you.

Choosing the Right Business Structure

We get it. Choosing the right business structure for your business can be challenging!

Still, it's worth taking the time to make the right decision. As we mentioned, how you set up your business affects its growth, the taxes you pay, and your obligations for reporting and compliance.

Really, the right choice comes down to what you need as a business owner, and what your business needs.

A few key points to consider:

• Liability protection.
• Tax implications.
• Administrative complexity (compliance and reporting obligations).
• Your long-term goals.

Every business structure, whether it's a sole proprietorship, partnership, LLC, or corporation, has its own advantages and challenges.

Ready To Incorporate? Reach Out Today

As you can no doubt see, incorporating your business offers numerous benefits, from protecting personal assets and gaining tax advantages to enhancing credibility and ensuring business continuity.

We’ve outlined the steps to incorporate, the key advantages, and the different types of corporations to help you make an informed decision. Choosing the right business structure is just one of many decisions you’ll need to make for your business, but it’s essential for your business’s longevity.

The incorporation process can be challenging (that includes deciding if it’s the right choice for your business). The good news is that you don’t have to do it alone!

We highly recommend seeking professional guidance to make the path to incorporation easier. Contact LLC Attorney today to explore your options and set your business on a path to lasting success.