Should I incorporate my business? (Part Two)

Should I incorporate my business?  (continued...)

Let's continue our conversation about incorporating a small business and important reasons to consider forming a corporation.  Last time we touched on limited liability and today let's explore income tax savings and transferability.

Income Tax Savings.  From an income tax perspective, a sole proprietor pays self-employment taxes on the net profit of a business.  As the net profit from the business operations increases over time, the owner may be able to reduce the amount of self-employment taxes by incorporating as a "S" corporation and taking only a portion of the net profits as officer's salary, while treating the balance as shareholder distribution.  S corporations are pass-through entities for income tax purposes and no tax is typically paid at the corporate level.  At the end of the year, the shareholders receive a K-1 tax form showing their proportionate share of profits (or losses) which they will include on their individual 1040 tax returns each year.

Transferability.  The third aspect mentioned above, ease of transferability of ownership, is especially important where a partnership business is incorporated, or where there are two or more shareholders operating the corporation.  Frequently, the shareholders will enter into a buy-sell agreement which deals with the legal issues arising from the incapacity or death of a shareholder, or when one of more of the shareholders wishes to sell or transfer his or her interest in the corporate business.

An alternative to the corporation is the limited liability company.  These types of entities are similar to corporation in that they offer limited liability and ease of transferability of membership interests, but they generally do not offer the same income tax savings to the owners as the corporate entity.

I hope that this helps for those of you considering incorporating.  The foregoing is but a brief overview of a complex subject and the reader is cautioned to seek the advice of an experienced business attorney and their accountant before proceeding with the incorporating process.

Should I incorporate my new business?

January 16, 2013

Should I incorporate my new business? (Part One)

This is a question I am often asked my clients in my business law practice.  My immediate response is just as often: "It depends".

In the aftermath of the Great Recession of 2008 many individuals have been laid off their jobs, or upon graduating from college cannot find a job.  Many of then have decided to start their own small businesses in order to use their skills and earn a living.  Typically, an individual will operate a new start-up business as a sole proprietorship.  There are few legal requirements for doing business as a sole proprietorship beyond applying for a business license, filing a fictitious business name statement, and opening bank accounts for the business.  In some instances, where the type of business is regulated by state law, a professional license is also required.

If the business and the resulting revenue continue to grow, there is a point in time at which the owner may consider incorporating.  Here are three important reasons to form a corporation to operate a business.  First, limited liability for the debts and liabilities arising from business operations.  Second, income tax savings and benefits.  Third, ease of transferability of ownership interests in the business.

First let's look at Limited Liability.  Since a corporation, validly formed and operated, is an artificial person under the law, it is considered a separate entity and the assets and debts of the corporation are its own and not that of the shareholders, directors, or officers.   For this reason many banks and lending institutions will require the individual shareholders to personally guaranty and loans or lines of credit available to the corporation.  In other words, with a few exceptions, the corporation's creditors cannot sue the shareholders, directors, or officers personally absent a personal guaranty of the debt signed by them individually.

Keep posted for our next post later this week where we will focus on income tax savings and transferability.  As always the foregoing is but a brief overview of a complex subject and the reader is cautioned to seek the advice of an experienced business attorney and their accountant before proceeding with the incorporation process.