Incorporation offers tax benefits, legal protections, flexibility, and for small businesses
If your small business has taken off and you’re wondering about the next steps, congratulations! Changing your business’s legal structure from a sole proprietorship or partnership to a C corporation might be the right move.
Here are some benefits of incorporating as a C corporation.
First, a brief review
When starting a business, the quickest and least expensive option is to become a sole proprietorship. Aside from registering your business name and securing a business license, if required by the laws of your jurisdiction, your legal and tax responsibilities are minimal.
If you want to share business risk and responsibilities with a partner, creating a general partnership is a flexible option, and its legal and tax requirements are similar to the sole proprietorship.
Neither sole proprietorships nor partnerships are considered separate legal entities. They are not required to incorporate, a process that varies by state but typically requires filing legal documents and paying a fee.
Business entities required to incorporate include:
-
C corporations
-
S corporations
-
limited partnerships
-
limited liability companies (LLC)
-
professional corporations (PC)
Many smaller businesses choose to become pass-through entities such as S corporations and LLCs. These entities pay no corporate taxes, and business revenues and losses are accounted for on the owners’ personal tax returns.
The C corporation is the most common type of incorporated business structure. Almost all larger corporations in the U.S. are C corporations. All companies considering going public, seeking venture capital, or taking on equity investors are also usually C corporations.
Reasons to become a C corporation
There are some compelling reasons to change from another business structure to a C corporation. At the top of the list are concerns about personal liability, taxes, and access to capital.
Incorporating offers business owners protection from personal liability. By forming a corporation, owners legally separate themselves from the corporate entity. If you feel exposed by any element of your business venture, ask yourself the following:
-
Has your small business increased in scope and value?
-
Do you expect your company to increase its exposure and add a large number of customers?
-
Is your company planning to launch a product or service, or expand its offerings past your original business plan?
If the answer to any of these is yes, it’s time to gain that legal protection.
If you are in a partnership or plan to bring in more company leaders who will want a stake in your business, incorporating makes sense. The process will force you to make tough decisions about your longer-term plans for the business. Having it all outlined in a legal document should eliminate disputes.
When you incorporate, you will be required to define the company ownership, assign officers, and in most cases issue stock. Stock options can be a cost-effective way of making your employee compensation package more attractive. If you can issue stock, you have the potential to lower your cost of doing business by offering third parties discounted access to equity.
Being a C corporation gives you increased access to capital because many investors prefer to work with incorporated entities. Officers of C corporations can issue different classes of stock, which is helpful to startups.
Because the C corporation is a separate legal entity, it has its own credit profile. Owners will obtain loans and take on debt in the company’s name, not their own.
If you are starting a business and have concerns about personal liability or believe you will want to raise capital immediately, it may be worthwhile to begin as a C corporation.
The tax benefits of C corporations
Becoming a C corporation will yield some immediate and longer-term tax benefits. C corporations often qualify for tax credits and deductions that are not available to sole proprietorships, partnerships, or pass-through entities.
The 2018tax reform bill secured changes that favored C corporations. The corporate tax rate dropped from 35% to 21%. Since C corporation owners split their profit between themselves and the company, there are ways to carefully account for profits and losses to gain the most favorable tax rates.
Incorporating can lower employment taxes. In a C corporation, shareholders can be salaried employees. The corporation can fully deduct their share of payroll taxes. Supplemental or “fringe” employee benefits offered by a C corporation are also usually tax deductible. This allows businesses to offer extra financial incentives that might not otherwise be financially possible.
Only C corporations can deduct eligible charitable contributions as a business expense (not more than 10% of taxable income per year).
In addition to being more attractive to potential investors, C corporations are the only business structure that can support 401(k) business financing. Under this program, Rollovers for Business startups (ROBS), entrepreneurs can fund new businesses with retirement funds without facing tax penalties or early withdrawal fees.
A decision with long-term consequences
Changing your company’s corporate status is a big step, as is incorporating a new business venture. In either case, you should have qualified legal and financial advisors guiding your way.
At Franco Blueprint, we help business owners make the best decisions about managing their accounting needs. We can give you an honest assessment of your existing business structure and guide you through incorporation if that is what is best for you.
It is our business to assist small business owners and help them secure their livelihoods during times of crisis and beyond. Contact us for a free consultation today.