If you're thinking of starting your own business or if you're ready to take your home-based business to the next level, this would be a good time to consider incorporating.
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There are several levels of incorporation that involve different aspects of control, liability and tax issues. Each has its upsides and downsides. But, how do you decide which type of corporation is right for you and your business?
We can help you make the right decision about incorporating your business. We've got the tips you need and a simple breakdown of different types of corporations you might consider for your business.
What to Consider Before Incorporating
- Are the incorporation laws in your state good for your business? Each state has its own laws. Shop around if location is not an issue, but know that you may have to file as a foreign corporation while operating in a state other than where you're incorporated.
- How big will your business be at the start? Think about how many employees you will employ and the amount of receipts you'll be billing.
- How do you plan to raise capital? You'll need to think about whether you're going to raise capital through your own sources or shareholders.
- How much control do you wish to keep over your business? Your control over your business is directly related to the type of corporation you want your business to be.
- How much paperwork do you want to do? Incorporating is not an easy process, and you need to think about how much of the heavy lifting you want to do.
- What is the business's vulnerability to lawsuits? The type of corporation you want for your business will make a huge difference in your vulnerability to lawsuits.
- At what point do you want the business's profits taxed? Tax issues are major considerations in incorporation, and you need to consider how they will impact your business before you incorporate.
Your Options for Incorporation
Sole Proprietorship The business is owned and operated by one person. All you do is give yourself a name, get a business license and start operating. Your personal assets are at risk in event of a failure or lawsuit. Your tax forms will be filed with your personal income tax return.
- The upside: You have sole responsibility for the business.
- The downside: You have sole responsibility for the business.
The business is owned and operated by two or more people. Control is split among the partners. This is easy to organize, but you'll need legal contracts drawn up for the partners. The owners' personal assets are at risk in event of failure or lawsuit. In addition to personal income tax forms, you'll need to file a Form 1065 (Partnership Return of Income).
- The upside: Other parties share in the investing and operation.
- The downside: Partners could end up disagreeing, creating legal problems.
The business is owned by two or more people. The amount of investment and responsibilities of the individual partners are determined by contractual delineation. To organize, you give yourself a name, get a business license and start operating. The owners have unlimited liability unless stipulated by contracts between the partners. In addition to personal income tax forms, you must file a Form 1065 (Partnership Return of Income).
- The upside: Other parties share in the investment and operation.
- The downside: Parties could end up disagreeing, creating legal problems.
Limited Liability Corporation
The business is owned and operated by members. You have total control. To get started, in most states, you must file articles of corporation. Because this is a limited liability corporation, your personal assets are not at risk. Depending on the structure of your business, you may be taxed as a partnership or corporation.
- The upside: You have the control of a sole proprietorship with the protections of a corporation.
- The downside: You have to deal with the paperwork of a corporation.
The business is owned by shareholders. Your control over the business will be checked by your board of directors. You must file articles of corporation, and you will be continually monitored by local, state and federal agencies. The shareholders have limited liability for the corporation's debts. You will need to file IRS Form 1120 Corporation Income Tax Return, Form 8109-B Deposit Coupon and Form 4625 Depreciation.
- The upside: You can raise money by issuing stock.
- The downside: You will pay higher overall taxes because dividends to shareholders are not deductible from business income.
The business is owned by shareholders. Your control over the business will be checked by your board of directors. You must file articles of corporation, and you will be continually monitored by local, state and federal agencies. The shareholders will have limited liability for the corporation's debts. You will need to file IRS Form 1120S Corporation Income Tax Return, Form 4625 Depreciation, Form 1040 Individual Income Tax Return, Schedule E and Schedule SE.
- The upside: You can raise money by issuing stock and treat earnings as distributions passing directly through to shareholders and their personal tax returns.
- The downside: Any shareholders working for the company must pay themselves wages, meeting the standards of reasonable compensation.
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