Why should I "incorporate"?
First, let's define "incorporate." This term has historically meant forming a corporation to own and operate business assets. With the popularity of a relatively new type of business entity, the limited liability company (or LLC), this term, as it is commonly used, now refers to forming both corporations and LLCs.
There are several reasons to incorporate. Some are legal, some are tax-related. The most important legal reason is that a properly formed and operated corporation or LLC can shield the owners from liability for the business' debts and obligations. On the tax side, forming an entity can present different tax options that will have different tax consequences, both good and bad. So new business owners should always consult with a competent tax advisor.
What is the difference between an S Corp, a C Corp and an LLC?
First, it is important to differentiate among legal entity types and tax elections, as this concept is often confused. Corporations and LLCs are legal entities that are authorized and governed by state statutes. The S Corp and C Corp names are used to describe different income tax elections, and this status does not impact the actual legal structure of the entity.
So legally, there is no difference between an S Corp and a C corp - both are references to an ordinary corporation formed under state law. The difference lies in the tax treatment of the entity and its owners. When a business person forms a corporation, the owners must make an election as to how they wish to be taxed for income tax purposes. S corps are generally taxed only at the shareholder level, while C corps are taxed at the entity and shareholder levels. There are many other differences in the taxation of these two classifications, and one is not necessarily better than the other for all businesses, so again it is advisable to check with an accountant or tax attorney to make sure the proper choice is being made for each particular business.
An LLC is just another form of state law business entity, and LLCs are very similar to corporations in that the owners are generally not liable for the business' debts and obligations. An LLC is not an income tax classification, however. The owners of an LLC must make an election to be taxed as a sole proprietorship, partnerships S corp or C corp, depending on what election is available and will provide the desired tax effects.
Can I still get sued if I incorporate my business?
Unfortunately, the answer is yes. Although the owners of corporations and LLCs can be legally exempt from being liable for the business' debts and obligations, there are a number of ways that this protection can be circumvented. First, if a business owner does not operate the business properly, the owners can be liable. There are many guidelines to follow to prevent this, and most of them are common sense, but observing these formalities must be a priority for the business owner. Second, business owners are often asked to personally guaranty business obligations, such as bank loans, equipment and office leases and company credit cards. Any such personal guaranties will allow the creditor to proceed directly against any business owner who signed the guaranty - unfortunately, these guaranties are common and often unavoidable for startup businesses that do not have established credit. Third, if a business distributes or transfers its cash or assets, for less than fair value, and cannot pay its creditors, the recipients of those assets (usually the business owner, a family member or an affiliated company) can be liable to the creditors. There are other examples, so it is important for a new business owner to have a clear understanding of the do's and don'ts.
What services and advice do I need to properly incorporate my business?
There are now many choices available to help a small business person when he or she decides to "incorporate," even on-line services that purport to save the business owner a few dollars. It is a simple matter to fill out a corporate or LLC registration form and file it in the Secretary of State's office, and this will technically create the business entity. But the business person should be looking for help with several other things, such as:
- Discussion and preparation of the necessary internal documents that govern the entity's management and ownership rights, including items like corporate bylaws, shareholder agreements, close corporation agreements, LLC operating agreements, buy-sell agreements, etc.
- Advice as to the various types of legal entities and tax classifications.
- Advice as to how to preserve the limited liability protection potentially offered by the new business entity.
- Instructions as to the proper way to sign documents and structure company paperwork like business cards, letterhead, labels, bank accounts, etc.
- Standard terms and conditions for purchases and/or sales.
- Referrals to qualified accountants and insurance agents.
- Referrals to local business groups or associations that can help the business save money and prosper with member benefit, like insurance savings, workers comp savings, health insurance group programs, networking events, etc.
- Advice as to how to protect valuable business information, names, trademarks and intellectual property.
The relatively small investment it takes to properly set up business documentation and operations is likely to pay huge dividends down the road by saving future hassles, expenses and legal fees.
