Pros and Cons of Incorporating Your Small Business

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Incorporating a small business has many benefits, but there are also some downsides too. Here’s what you need to know to decide whether to incorporate. 

If you are running a small business, you have to decide how to structure it. Incorporating it is one option.

You could choose to form an S-corporation or a C-corporation, but many small business owners opt for an S-corp because it is a pass-through entity. That means the business itself does not pay taxes. Profits and losses pass to owners. C-corporations, on the other hand, do pay business taxes and owners pay taxes when profits are distributed so you risk double taxes (but you do get more flexibility in terms of who can own the company).

There are both pros and cons to incorporation as either an S-corp or C-corp, so be sure to consider both the advantages and disadvantages when deciding how best to run your business.

These are some of the biggest advantages of incorporation

Here are some of the biggest benefits of choosing to organize your business as a corporation:

You get liability protection. When you have incorporated your company, it becomes its own separate legal entity. It exists independently from you, which provides you with strong protection from liability. If someone sues the business or the company goes into debt or something else goes wrong, your personal assets will not be at risk — only the company’s will (as long as you kept your money separate).You have tax flexibility. If you choose to incorporate as an S-corp, you will operate as a pass-through entity. If you choose to incorporate as a C-corp, the business will pay taxes. Regardless of whether you operate as an S-corp or C-corp, you can opt to pay yourself a salary from the company and then take additional money out of the business as distributions or dividends. This allows you to avoid self-employment taxes on some of your earnings. You could also save money because certain other expenses can become tax-deductible, such as health insurance premiums.It’s easier to transfer ownership of your business. Since the company exists independently of you, it’s more likely to continue after you no longer want to operate it. You can sell or gift shares to others, giving them an ownership stake in the business. There is more flexibility in who can own shares of a C-corporation, but both S-corps and C-corps provide this benefit.

I run my business as an S-corporation because I appreciate the tax flexibility and the liability protections.

I was able to reduce my tax bill considerably by forming an S-corp, paying myself a reasonable salary that is less than the company’s total earnings, and then distributing the rest of my company profits to myself (and thus not paying Social Security or Medicare taxes on those distributions).

These are some of the biggest downsides of incorporating

There are also some downsides to incorporating as well.

There’s added paperwork (and cost). You will have to file paperwork to incorporate and often pay a fee to do so. And you may have to pay an annual filing fee to your state. In my state of Florida, for example, I must pay a $150 per year fee to submit an annual report for my for-profit company. I also have to employ a payroll service to pay myself my salary and pay fees to the state for things like unemployment benefits for myself — and you probably will too depending on your state’s rules. Your company also has to file a tax return, even if it is a pass-through S-corp, which adds accounting costs. And you’ll need to have annual meetings and keep corporate records.Taxes can be higher. If you are a C-corp, the business must pay taxes and you must also pay taxes when you receive a share of company profits, so you may be taxed twice. While this isn’t an issue for S-corps, some states also don’t have favorable tax rules for any corporations, so your tax bill can sometimes end up higher. This is not the case for me because Florida doesn’t charge separate taxes for S-corps, but it is in other states, such as Washington, which subjects S-corps to a business and occupation tax. You should check the rules with your state’s Department of Revenue.It can be harder to access your own money. You need to keep personal and business assets separate when you incorporate. If you are paying yourself a salary that’s less than your company’s profits, you may need to leave your money in your business accounts until you are ready to distribute profits. Doing this too often could cause a red flag with the IRS, which might investigate whether the distributions are just salary in disguise.

You’ll want to consider the advantages and disadvantages before you move forward with incorporating.

If you do decide to incorporate, you could talk to a lawyer to help you file the paperwork. You can also do it yourself, as your state generally will have the forms online you need to file. If you aren’t 100% sure of the legal or tax implications, though, or don’t know exactly what paperwork to file, getting professional help is likely your best move.

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