If you’re getting ready to launch a company or are already up and running as a Sole Proprietorship, you might be thinking about formally incorporating the business.
Forming a Corporation might sound daunting, and it does require some actionable steps to get it registered and in compliance with the state, but the benefits of incorporating far outweigh any effort involved. In this article, we’ll explore those benefits and I’ll outline the basic steps of getting registered as a Corporation. But first, let’s review exactly what it means to incorporate a business.
You can technically operate a business without filing any paperwork or registering the company with the state government. Many entrepreneurs choose to operate their business as a Sole Proprietorship or Partnership to get started. While these types of businesses are easy to set up and run, there are some real disadvantages associated with them. The most significant downside is that there’s no legal distinction between the business and its owners, meaning that if the company gets sued or incurs business debt it can’t repay, the owners are personally liable. There also are other disadvantages, including tax concerns, difficulty in raising capital, limited growth opportunity, limited company lifespan, inability to transfer ownership, and a perceived lack of professionalism.
When you incorporate, the business becomes a formally recognized entity by the state in which it’s registered. It’s a legal business entity that exists separately from its owners, protecting the owners’ personal assets of the business. When you incorporate your business, you establish a legal distinction between the entity and yourself. But those are not the only advantages. Let’s take a deeper dive into the benefits of incorporating your business.
8 Advantages of Incorporation
1. Asset Protection Through Limited Liability
A properly formed corporation is recognized as a separate legal entity with its own Federal Tax Identification Number, sometimes referred to as an Employer Identification Number. The Corporation is responsible for its liabilities and debts, but the owners are not.
As an example, the ABC Corporation has $5,000 in corporate assets (cash and computers). Business is slow, and there are 12 months of rent remaining on the lease. If the Corporation was properly formed and the lease was executed by “ABC Corporation,” the landlord will only be able to reach the $5,000 of business assets when attempting to collect the rent money. The shareholders (or owners) of the corporation will not be liable for any payments remaining on the lease, because the corporate structure provides protection of personal assets.
A Sole Proprietorship or Partnership, by contrast, the company owners are personally liable for all business obligations. So, the business owner who did not incorporate or form a Limited Liability Company (LLC), which is a different type of entity than a Corporation but also provides personal liability protection, could be held personally liable for the remaining rent money. They’d have to come up with the money, even if it means using personal savings or selling an asset, such as a house or car.
For true asset protection and to avoid personal liability, it’s advisable for most business owners to incorporate a business. Note that any benefits of incorporating are likely to be lost if a business commits fraud, neglects corporate formalities, or commingled funds, but a properly operated C Corporation or LLC limits the liability of its shareholders to the amount they invested in the company.
2. Creation of a Corporate Identity
A startup incorporation assists new companies in gaining credibility with their clients and partners. Marketing studies demonstrate that adding an “Incorporated” or “LLC” to the end of a business name provides a sense of credibility and trust. A surefire way to success in business is to conduct your business legitimately and with honesty, qualities that are enforced by regulations with which an incorporated business must comply.
3. Perpetual Life for the Business
A Corporation is a separate legal entity that not only exists apart from its owners but has a perpetual life. If one or more owners leave the company or die, the business continues indefinitely, until it is dissolved. That’s a different situation than for a Sole Proprietorship or Partnership, which ends with the death of an owner or owners. With a Corporation, shares of ownership can be sold, gifted, or bequeathed to others.
4. Transferability of Ownership
Because a Sole Proprietorship does not exist separately from its owner, it normally cannot be transferred to a third party. The Corporation, however, provides an excellent vehicle for transferring ownership through the exchange of assets for stock.
5. Ability to Build Credit and Raise Capital
The ability to raise capital by leveraging the inherent value of a business shouldn’t be underestimated. The historical purpose of a Corporation was to form an entity with distributed ownership. In a sense, it is like splitting up the worth of an enterprise into many pieces. Control can be retained by holding on to a majority of shares, while investment capital can be raised by selling some shares.
Investors may be keen to take risks with an offer of partial ownership. The stock then has a real or immediate value as well as a potential value. Many private equity firms will only invest in a company when their money can be backed up by held stock, an avenue not available to non-corporations.
6. Flexibility With the Number of Owners
C Corporations, the most common type of incorporation, and LLCs generally allow for an unlimited number of shareholders, meaning there’s no limit to growing your company. S Corporations, which are Corporations that meet certain qualifications that enable the IRS to give them special tax status, are limited to 100 shareholders.
7. Potential Tax Savings
While there are some disadvantages to being taxed as a Corporation, there also are potential tax savings. Corporations are permitted to reduce taxable income using legal business deductions such as insurance, advertising and promotion, insurance premiums, depreciation, and business interest and bank fees.
Also, a Corporation pays half of Social Security and Medicare taxes directly from its business account, while owners chip in the other half. Owners of an unincorporated business are charged with paying the full amount of these taxes, known as self-employment taxes. In 2024, the self-employment tax rate is 15.3 percent of net earnings.
Paying corporate taxes can be more advantageous for owners than paying additional individual income tax, as non-incorporated business owners must do if they generate a profit. There also are opportunities to shield income from taxes through a 401k plan (or other retirement mechanism), a healthcare plan, life insurance, and charitable contributions. While some of these mechanisms have parallels in non-incorporated structures, a corporation has the advantage of structuring benefits through standard organizational plans.
8. No Attorney Fees
You might think that incorporating a business involves hiring a lawyer and paying big legal bills, but in most states, it does not require costly attorney fees. In fact, if you’re experienced with business filings, you can visit the applicable office in your state and file articles of incorporation yourself.