Millions of small business owners dream of incorporating. They’ve heard or read that incorporation is the “holy grail” of the world of commerce and has the power to bestow wealth the likes of Steph Curry’s net worth, happiness, and sound sleep. For decades, there has been a ton of misinformation floating around about what it means to incorporate a business. Sadly, many of those falsehoods and half-lies still hang in the air as the second decade of the century comes to a close.
What’s the real story about incorporating? The cold, hard truth is that there are pros and cons to the move that so many owners dream about. Sometimes, in fact, it makes very good sense to incorporate your business. Sometimes it doesn’t. The following should help clarify the matter for business owners who think “Inc” might be in their future:
Know the Disadvantages of Incorporating
When you are the owner of a corporation, it helps if you like paperwork because you’ll get the opportunity to file two tax returns every calendar year. And be careful not to try to deduct any corporate losses on your personal return. It’s a federal crime. You’ll need to keep the two returns completely separate, file on time, and pay taxes with both. Besides the tax return, corporations are required by law to keep registers of directors, minutes of meetings, a list of registered shares, and much more. Yes, you can outsource the task but that’s just another expense you might not have planned for.
Be careful with losses on corporation tax returns. As noted above, you can’t mix corporate and personal tax situations. Corporate losses can only be used to offset corporate income in the current, prior or future years. You can’t ever use a corporate loss on a personal tax return, no matter how big it is and no matter how much it has impacted your personal financial situation. Corporations have limited liability by default, according to the laws of every U.S. state. However, if you are a new company, it’s likely that lenders will demand you put up some of your personal assets as collateral for a loan. Presto! You have now lost one of the main reasons many people incorporate.
Know When it Makes Sense to Incorporate
If your corporation is large, and well-known enough to obtain loans without putting your personal assets on the line, you’ll enjoy limited liability that comes with incorporating. Many companies go the “Inc” route for this very reason. The law protects directors of corporations from legal action, but the corporate assets remain at risk. Another key advantage of incorporating is that it’s usually much easier to raise funds. Corporations can issue shares of stock to raise money via equity markets. It’s common for corporations to approach angel investors and others who want access to early share sales, like venture capitalists.
Forming a limited liability company or setting up simple sole proprietorship can be wise alternatives to incorporating. There are minimal or no setup fees and you get many of the same advantages you’d get with incorporation.