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Incorporating – Pros & Cons

January 31, 2010

Deciding whether to incorporate a new business is one of the first decisions for a new business owner. It’s a complex decision with important benefits and drawbacks. One of the benefits is that it limits the owner’s financial liability because the firm is responsible for its own taxes and debts. If the firm is sued, if debts are unpaid, or if financial difficulties force bankruptcy, the owner’s liability is limited to the value of the stock he or she holds in the corporation. Personal assets are not at risk, with certain exceptions. The owner may be personally liable if negligence is at issue or if the company is the subject of civil litigation. Additional personal insurance can help protect the owner against civil penalties. 

A corporation also makes it easier to transfer ownership in the company. Stock shares may be distributed to family members or sold to investors. A corporation may also encounter fewer difficulties in raising capital, borrowing money and obtaining credit. And, with multiple owners, a corporation affords greater stability for the business’s short- and long-term prospects, especially in the event of a principal owner’s untimely illness, disability or death. 

The chief financial drawback of incorporating is double taxation. A company structured as a corporation first pays taxes on profits. Then stockholders – who are likely to be the owner-operators — pay income taxes on the dividends they receive. 

However, an S corporation sometimes called a “subchapter S” or “small business” corporation is not taxed as a corporation, while also providing limited personal liability protection. Stockholders report their share of business profits or losses on their individual tax returns. This form of incorporation is common with small companies. In either case, bookkeeping requirements are more extensive due to the higher level of detail required in tax filings. 

Corporations are subject to both state and federal regulations. If you plan to expand your business to other states, you may have to pay additional fees in each jurisdiction. In addition, the corporate charter or articles of incorporation must specifically state the firm’s business activities. If you want to expand the activities of the business, you may need an amendment to the charter. 

One final drawback of incorporating may be the cost.  For example, the state of Pennsylvania requires business registration, which can generate legal fees. Lastly, you can expect recurring costs, such as annual franchise or corporate income taxes, plus federal corporate income taxes. 

Before you decide if or how to incorporate a new small business, consult a tax attorney. And for expert advice about starting and growing your business, contact Lancaster SCORE, “Counselors to America’s Small Business.” More than 50 expert business mentors offer free, confidential counseling to emerging and existing small businesses. Call us at 717-397-3092 or find us online at www.scorelancaster.org

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