Another tax deadline has come and gone. That’s right. It’s time to breathe a great big sigh of relief. You’ve sent in your taxes and you’re ready to tackle whatever comes next.
For those of you dreaming of starting your own business one day, now’s the perfect time to focus on turning those aspirations into reality. More entrepreneurs are coming into their own as business owners. And it’s a good thing. After all, small businesses are the backbone of our economy. According to the Small Business Administration (SBA), small firms are responsible for generating 64% of net new jobs over the past 15 years.
If you’re ready to get serious about your entrepreneurial dreams, there are a few things you’ve got to keep in mind in order to make your business official. And the sooner you address the legal matters, the better. As an entrepreneur myself, I understand that legal paperwork doesn’t always rank high on the priority list. But getting your legal ducks in a row will help you grow more smoothly, avoid legal pitfalls in the coming years, and yes, maybe even help you save money on taxes.
Incorporate your business
Many small businesses consider themselves ‘too small’ to worry about incorporation. After all, having an Inc. after your name means you have a big staff and rows of cubicles, right? Well, not exactly. Even if you’re a freelance writer or own a family catering business, incorporating or forming an LLC can be a smart idea. Here’s why:
• Liability/personal asset protection: Without incorporating or forming an LLC for your business, your own personal savings and property are at risk to settle any debts of the business. Once your business is a corporation or LLC, it becomes a separate legal entity. This means that the corporation (and not you) is responsible for all of its debts and liabilities. I know you don’t anticipate angering clients or defaulting on any payments. And most likely, you’ll never encounter this kind of trouble. But things do happen. And a legal business structure gives you peace of mind that your retirement savings won’t be wiped out by your business venture. Also keep in mind that creditor judgments can last a total of 22 years, so you need to be thinking about protecting whatever assets you’ll have in the future, not just what you own today.
• Tax benefits: While liability protection is the main benefit for incorporating or forming an LLC, in many cases, corporate tax rates are lower than individual tax rates. And corporations and LLCs often qualify for additional tax benefits and deductions that aren’t available to individuals. Of course, specific circumstances vary, and you should consult with a CPA or tax advisor about your own particular tax situation.
• Added layer of privacy: When you incorporate or form an LLC, there’s an added layer of privacy. In many cases, the registered agent of your corporation goes on record, and not your home or business address.
• Other benefits: In addition, a corporation offers a known stock structure with freely transferrable shares, which makes it attractive to investors. And, you can offer more employee incentives, such as stock options, group health insurance plans, 401k and other retirement plans, and more.
Choosing the right business structure
Choosing your business’ legal structure is a critical decision, as it can impact the taxes you pay, your ability to raise capital, as well as the amount of paperwork you’ll have to contend with. The three most popular business structures in the U.S. are the LLC (Limited Liability Company), S Corporation and C Corporation. Here are some basic definitions:
• LLC: An LLC is a hybrid of a partnership and corporation. There are no shares. An LLC’s main benefit, as the name suggests, is to limit the liability of the owners (separating your personal property from company property). An LLC does not file separate taxes; all company profits flow through to the owners and are taxed at the personal income rate.
• C Corporation: A C-Corporation also known as a “C-Corp” or also sometimes referred to as a “General-For-Profit (GFP) Corporation is a legal entity. There are strict requirements to form and dissolve it. A C-Corporation can earn money, take out loans and be sued (again, this is a major benefit, since liability shifts from the owners to the corporation itself). A C-Corp is taxed separately and the company must file its own tax returns. And a C Corporation can attract investors and earn capital by issuing stock.
• S Corporation: An S Corporation actually starts off as a C-Corp and then soon after incorporation, the owners submit Form 2553 to the IRS to be treated as a pass-through entity. Like a regular corporation, an S Corp is a collection of stockholders who share company ownership. But in this case, the income/loss of the company is passed through to each shareholder’s personal tax statement.
So back to the heart of the matter: which business structure is right for you? Much will depend on how much formality you want. An LLC is great for businesses that want legal protection, but minimal formality — i.e. no exhaustive meeting minutes or addendum filings. It’s also the perfect structure for a start-up who will have foreign owners. An S Corporation is great for a small business owner who can qualify: The IRS places limits both on the number of owners and on who can be an owner in an S Corporation. A C Corporation should be used for those businesses that plan to reinvest their profits back into the company or seek funding from a VC.
As for timing….since the main benefit of incorporation is liability protection, the sooner you incorporate (or form an LLC), the better. There’s simply no reason to wait and potentially expose yourself to any more liability than you need to. Now’s a great time to invest a little time in getting your legal structure squared away and your business will be set for many tax days to come.
Nellie Akalp is CEO of CorpNet.com her second incorporation filing service based on her strong passion to assist small business owners and entrepreneurs in starting and protecting their business. She has formed over 100,000 corporations and LLCs across the U.S. To learn more about Nellie and see how she can help your business get off the ground quickly and affordably, please click here.