Today, people increasingly incorporate their businesses to save on taxes and get many other financial benefits. Therefore, incorporation has become quite popular in recent years. But you're wondering - is it the right step for your business? We will explain everything you need to know, so keep reading to see how it works and learn all the advantages of incorporating yourself!
What Does It Mean to Incorporate Yourself?
Incorporating yourself is forming a legal entity that effectively separates your personal affairs and business operations.
This means that your personal and business finances and investments are now segregated. Your business becomes its own separate legal entity with its own name, tax ID number, and legal status. Therefore, your business can enter contracts, sue and be sued, and own property in its name.
Moreover, you will become the corporation's owner. You will also be entitled to various tax benefits and the ability to raise capital through stock sales.
This is a great decision if you want to protect yourself and your resources from any legal disputes that may arise from your business operations. It also provides legitimacy and credibility to your business, making attracting investors, partners, and customers easier.
How to Incorporate Yourself: Key Steps
Here are seven key steps to follow to effectively incorporate yourself:
Choose a Business Name
Come up with an original name for your business that isn't already in use, and conduct a name search in the state where your business will be based.
Select a Business Entity Type
There are four main types business entity types: sole proprietorship, Limited Liability Company (LLC), S Corporation (S Corp), and C Corporation (C Corp). Choose a business entity structure that best suits your needs. Please note: If you opt be treated as a SMLLC, you will be a sole proprietorship for tax purposes and if you are a multimember LLC you will be treated as a partnership unless you elect to be treated as an S Corp or C Corp.
Get Necessary Permits and Licenses
Register for any necessary licenses with state, county, and local agencies. Failing to get these permits can lead to legal issues and fines.
Acquire Business Insurance
Business liability insurance will protect your personal assets in case of a lawsuit or mishap. You never know when an unforeseen event can occur and threaten your business.
Create Corporate Bylaws
Corporate bylaws outline how your business will be run, who makes decisions, and how procedures will be carried out. This way, you will establish a solid framework for your business and mitigate the risk of disputes and conflicts.
File Articles of Incorporation
These documents outline a corporation's purpose, structure, and internal regulations. The secretary of state's office reviews and approves these filings before issuing a certificate.
Maintain Corporate Records
Keep a minute book, shareholder register, and other important documents up to date. The minute book documents all official company meetings and actions undertaken by directors and shareholders. The shareholder register lists all shareholders and their holdings and any transfers or changes.
As you can see, incorporating yourself takes a little time and effort. However, it can offer significant financial and legal benefits in the long run.
What are The Requirements for Incorporation?
In order to incorporate yourself, you must meet certain legal requirements.
The first legal requirement for incorporation is to file articles of incorporation, as we've already mentioned. Then, you need a registered agent. Most states require a corporation to have an agent responsible for receiving legal notices and other important documents on behalf of the business.
Next, you need corporate bylaws - a set of rules that govern how the business will be run. You will also need to file annual reports. They include updated information about the business, such as the directors' and officers' names and addresses, the company's current agent, and the number of shares of stock outstanding.
Finally, as a separate legal entity, a corporation has to pay federal, state, and local taxes. This includes income tax, payroll tax, and any other applicable taxes. Be sure to consult with a professional accountant, as they will be able to help you with tax preparation, which will make your job way easier.
What Are the Tax Benefits of Incorporating Yourself?
As a sole proprietor, you must pay self-employment tax, which can significantly burden your finances. However, incorporating yourself comes with many tax benefits, starting with:
One of the biggest reasons to incorporate your business is to reduce your tax liability. As a business owner, you will be able to take advantage of several tax deductions and benefits. For example, you may be able to deduct expenses such as rent, equipment, and supplies. Additionally, you could take advantage of tax credits for things like research and development.
Incorporated businesses may also be eligible for a lower flat tax rate compared to sole proprietors. This can result in significant savings for companies with higher net income.
Moreover, by separating your personal and business finances, you can shield yourself from potential losses and lawsuits.
Incorporation can also be a way to reduce social security taxes. As an incorporated business owner, you can pay yourself a salary and withhold those taxes from your paychecks.
It is important to note that incorporating may involve additional paperwork and fees. However, the tax benefits and personal asset protection can significantly outweigh these costs.
A Reduction of Self-Employment Taxes
Self-employment tax is necessary for those who own their own company. It covers both income taxes and Medicare taxes. In order to pay them, you need to understand what they are and how they work.
When you own your company, you may have several business assets that can be used to reduce your taxable income. Depreciation, business expenses, and other tax deductions can help decrease your liabilities.
When you incorporate your business, your income is not subjected to self-employment tax. This means a reduction of self-employment taxes and an increase in business expenses you can write off. You will also enjoy tax benefits unavailable to sole proprietors and other small business owners.
Improved Retirement Plans
You will also be able to make better use of retirement plans. Many retirement plans, such as 401(k)s and IRAs, are available only to incorporated businesses. By incorporating yourself, you can take advantage of these plans and enjoy significant tax benefits. Additionally, you can make contributions on a pre-tax basis, which can help reduce your tax burden.
What Are the Other Benefits of Incorporation?
Besides taxes, incorporating yourself offers many other advantages to save money and improve your business activities. These benefits include:
Limited Liability Protection
Your investments will be protected if your business is sued or goes bankrupt. This is because a corporation is considered a separate legal entity from its owners, meaning that its debts and liabilities will not affect your finances.
Another benefit is that it can help increase your credibility with potential customers, suppliers, and partners. Incorporation shows that your business is a serious, long-term venture committed to its success and growth.
Access to Capital
Incorporating can also help you access capital way easier. This is because investors tend to view corporations as more stable and reliable than other business entities. Additionally, if you plan to take your business public, it is a necessary step in the process.
Flexibility in Business Structure
Finally, incorporating your business gives you more flexibility. For example, you can incorporate as an S corporation, allowing you to pass through your business income and losses on your personal tax return. This can help you save on taxes and simplify your accounting.
What Are the Differences Between Incorporated & Unincorporated Businesses?
The main difference is that an incorporated business is considered a separate legal entity from its owners. This means that the business is responsible for its own debts and liabilities, and the owner's personal assets are generally protected.
On the other hand, unincorporated businesses, such as sole proprietorships, do not have this separation. In this case, the owners are personally responsible for any debts and liabilities.
Another important consideration is the dividends paid to shareholders. Depending on your business structure, you can pay dividends to yourself, providing you with additional income and lowering your overall tax burden.
One more difference is how these businesses pay taxes and distribute profits. Incorporated businesses are subject to double taxation, where the company pays taxes on its profits. After that, the owners pay taxes on any dividends they receive. Unincorporated businesses do not have double taxation, as the profits and losses are reported on the owners' personal income.
In summary, incorporation can be a smart move for those in certain industries, such as freelancers, consultants, and small business owners. Whether you are self-employed or managing a team of employees, choosing the right structure can have a significant impact on your success. That's where the help of a professional accountant might come in handy!
How Can an Accountant Help You With Incorporation?
The incorporation process can be tricky, no matter how good it can be for your business. It's especially true when it comes to taxes. That's why it's so important to have an experienced tax accountant by your side if you're not sure how to do it all alone.
For one, they can help you decide which type of corporation is right for you. Different types of corporations come with different tax advantages and disadvantages, and they will know how to explain this to you in detail. A good accountant can also help you make sense of all the legal jargon and paperwork involved in the process.
Once you're incorporated, an accountant can help you with your tax return, ensuring you're taking advantage of all available deductions. They can also help you keep track of every expense that can be deducted from your net profits to reduce your tax burden. Therefore, their services can significantly help you even after you're done with incorporation.
As you can see, incorporating yourself is a smart move toward securing a successful financial future. We hope that our tips have been informative and useful in helping you make the right decision for your business!
About the Author
David Heistein, CPA
Dave is co-founder and managing partner at Profitwise Accounting. Dave is a Certified Public Accountant in the state of California, as well as an advanced QuickBooks Pro Advisor and Instructor. As a small business owner, he is dedicated to educating and informing other business owners on bookkeeping and accounting matters.