It’s fascinating how simply adding three letters after your business name instantly makes it shinier and suddenly more professional. I’m talking about “Inc.” or “LLC.”
This fancy new extension to your company name is one of the perks of incorporating your business. But what does it really mean to be incorporated and why should you do it?
Most small businesses start out as either a sole proprietorship or a partnership. But as they grow, they may want to change their legal status to a business structure that comes with more credibility. And this is where incorporating your business becomes a decision you have to make.
To put it simply, incorporation is the process of legally defining your business. Incorporating your business goes beyond business name protection. Not only will incorporation allow you to protect your assets strategically but it allows you to gain some tax advantages.
Incorporating your business does come with its pros and cons. Let’s start by exploring the advantages of incorporation:
This is perhaps the main advantage of the incorporated company. In a sole proprietorship, you assume all the liability of your company. This means that in the event that your business needs to repay debts, your personal assets such as your home or car can be seized. But when your business becomes incorporated, you’ll be recognized as a shareholder in a corporation and cannot be held responsible for the debts of the corporation.
Unlimited Life Span
Corporations have unlimited life spans. By definition, a corporation is an “an artificial creation of the law existing as a voluntary chartered association of individuals that has most of the rights and duties of natural persons but with perpetual existence and limited liability.” And because a corporation exists as its own entity, it enjoys a “perpetual existence.”
Want to lower your tax bill? Collect income from an incorporated business in the form of dividends rather than paying yourself a salary. And by choosing the timing of when to receive your income, you can optimize your income and taxes by collecting dividends during a time when you will pay less in taxes.
Furthermore, business tax rates are much lower than personal tax rates. By leaving funds in your business, you’ll be paying less in taxes by choosing to take them out at a later date when your individual marginal tax rate is not so high.
But while incorporating your business has its advantages, it does come with disadvantages that you will need to consider.
Incorporating involves a lot of paperwork. You’ll need to maintain books, corporate documents that need to be kept updated and take minutes from all your corporate meetings. You’ll also have to file two separate tax returns every year – one for your corporation and one for your personal income.
Incorporating will also cost you money. And while you can do it on your own if you have a background on the legalities involved in incorporating a business, you may not be equipped to deal with the technical processes that may require the help of an accountant and a lawyer.
And while we mentioned that incorporating your business does have its tax advantages, it also means less tax flexibility. Corporations, for example, are not eligible for the same personal tax credits that a sole proprietor would enjoy.
The decision to incorporate your business is a turning point for you as an entrepreneur. Adding “LLC” or “Inc.” after your business name gives it authority and a legitimacy that helps in your marketing and brand building. And as your business matures, so will your approach when it comes to the realities of your tax and legal situations.
Overall, this is an exciting time for any small business owner as you make a major decision for your business that validates its growth.
Until the next time,