You’ve finally come up with a fantastic name for your business, your business plan has been meticulously developed, and you’re ready to incorporate! However, when you research how to establish a business, you keep coming across the phrase “incorporation.” You attempt not to seem flustered as you quickly explain that you are still weighing your alternatives. Starting a business may be a tremendously thrilling experience. You not only have the thrill of working for yourself, the pleasure of doing what you prefer, and the duty of running a business you established with your own hands, but you may also be able to make some income doing it.
When it comes to tax planning for business owners, incorporating your business may make sense. Incorporating your business is a great way to take advantage of tax benefits that aren’t accessible to unincorporated businesses, some of which might save you a lot of money each year.
While corporations pay greater costs and must submit more detailed reports than sole proprietorships, there are advantages to consider. The protection it gives for your personal assets is a significant benefit of incorporating. As a single owner, you are personally liable for your firm’s liabilities, and your personal assets may be taken to satisfy company debt. If you incorporate, any legal difficulties your business may encounter are better protected, and your personal assets are more secured. Your personal losses would be restricted to the amount of money you’ve put into your business. One of the bigger advantages of incorporating is the tax advantages which we will discuss in this post.
When does a business become incorporated?
In contrast to legal business structures such as sole proprietorships and partnerships, incorporation establishes a distinct legal entity apart from its owners (shareholders). When a corporation is formed, each shareholder is given shares proportionate to their ownership percentage. Corporations may perform many of the same things as persons, such as buying property, signing contracts, opening bank accounts, and filing lawsuits.
However, if your business is small, you might ask if forming a corporation is required. The most common reason for forming a corporation is to avail tax benefits and reduce your personal liability for business debts. There is numerous tax advantages offered to incorporated businesses which we will further discuss in this post. When you switch from being a sole proprietor to forming a corporation, such as an LLC, you may take advantage of a number of tax breaks that aren’t accessible to individuals.
When you don’t incorporate.
If you are the sole owner of the business and you don’t incorporate your default status in the eyes of the IRS is a sole proprietorship. With this business structure, you don’t need to do anything to set up the sole proprietorship because this is the default tax entity for individuals conducting a business activity. As a sole proprietor, you only need to report your business income and expenses on your individual tax return.
A sole proprietorship is often the entry point for beginner entrepreneurs because it requires zero setup. Yet, it might not be the best business structure as your small business grows and evolves and may have tax implications. Depending on whether you’re a sole proprietor or a corporation, the tax requirements may differ.
Tax Advantages of incorporating your business
When deciding whether or not to incorporate your business, you should consider how your business will operate. One of the biggest reasons to incorporate your business is to keep your firm and its assets distinct from your personal assets, but there are also significant benefits when it comes to taxes.
The following are some of the tax benefits you might get after incorporating.
1. Distributing tax losses
You’ll almost certainly lose money as a business, especially in the beginning – most businesses do. In contrast to filing taxes as a person, a business may stretch out its tax losses over time. As an individual, you must accept the loss immediately, but as the owner of an incorporated business, you may delay your taxes. More precisely, if you have a high marginal tax rate as an individual and don’t want the funds, you can leave money for your firm and retrieve it later when your personal tax rate has leveled off.
2. Deductions for business expenses
A corporation can deduct any usual and necessary business cost, just as a sole owner or partnership. Additional costs that are deductible are common in businesses. Yearly franchise costs, annual report charges, and other state-level charges are examples of these expenses. Fees for tax preparation can be deducted as a business cost for a corporation. Keep records of all of your expenditures. Start-up costs, operating costs, and capital expenses are all included (land, business equipment, commercial property, etc.). These costs can be deducted at tax time and add up to a significant amount of money for your company. As an added plus, becoming an incorporated firm puts you at a decreased chance of getting audited.
3. Deductions for Social Security taxes
You’ll only have to pay social security taxes on the income salary you obtain as a result of establishing your firm. This saves you a lot of money in taxes and allows you to segregate your social security tax from the rest of your earnings.
4. Opportunities for lending
When it comes to asking for loans, business owners who do not incorporate may encounter greater hurdles than those who do. The fact that single proprietorships need less financial and tax documentation is one explanation for this. As a result, they may be unable to justify their earnings due to a lack of documents.
Incorporated businesses, on the other hand, frequently provide lenders with a detailed financial image of their business assets and liabilities, thanks to their corporation tax filings, which include balance sheets as well as income and cost information.
Benefits paid to employees by incorporated firms can also be deducted. You can’t deduct such perks since you’re an unincorporated firm with outside support. Incorporation generally comes with tax advantages for both you and your staff. Benefits like health insurance, life insurance, and travel and entertainment costs may now be deducted even if you are the sole shareholder and employee of your company. Best of all, qualified pensions or retirement plans (e.g. 401Ks) usually get a bigger tax break from businesses.
6. Safeguard Personal Assets
Keeping your professional and personal assets distinct is always a good idea. This comprises bank accounts, real estate, and other assets. You can secure your personal assets as an incorporated corporation, which is crucial in the event that something goes wrong in your firm.
If you’re sued as an incorporated business, for instance, you’re not personally responsible; only your business is. Your business’ assets are at risk, not your own house, automobile, or property, because establishing your business makes it a different entity.
You’re more likely to be considered properly as a business owner if your business is incorporated. In the market and in the tax world, you get greater credibility. If this is the case, you’ll be more likely to make money from people who believe in you and your business.
8. Earnings Flexibility
Another financial benefit of incorporating is that you can reduce your tax cost by receiving income in the form of dividends rather than salary, allowing you to be more flexible with your income options. You can manage your firm more creatively and satisfy a broad set of demands with income flexibility, which is especially important when you’re just starting out.
You might find that forming a business is a good option for you. Aside from tax benefits, incorporating your firm provides up a slew of new doors and prospects.
As previously said, incorporation provides business owners with several tax benefits that include but are not limited to health and life coverage, travel and entertainment deductions, retirement programs, educational perks, and dependent care help. Items that are only partially deductible by a sole proprietor may become entirely deductible under a corporation in particular cases. It’s important to think about numerous tax requirements while preparing in this area, such as discrimination restrictions that require benefit programs to cover all employees. Before incorporating your business, you must speak to our business attorney to weigh if the pros of incorporating our business outweigh the cons.
Other Reasons to Incorporate
There are a number of other important reasons why businesses choose to form a corporation and these include:
1. Protection Against Liability
Shareholders are shielded from corporate debts and other legal duties by corporations. Customers, lenders, workers, suppliers, tax authorities, landlords, and anyone else with a legal claim against the company can only seek payment or compensation from the company’s assets. A supplier with an unpaid invoice, for example, can sue the business, obtain a court judgment, and place a lien on the firm’s bank account, but it can’t normally seek remedies against the shareholders or their personal assets, such as homes and automobiles.
However, if the shareholders do not treat the corporation as a separate legal entity that owns and operates a business and do not consistently adhere to the corporation’s legal formalities (keeping separate bank accounts, segregating business and personal expenses, holding shareholder and director meetings, and so on), they risk losing their liability protection.
Forming a corporation is a suitable initial step if the founders of a firm wish to attract outside investors who want a financial stake in the company but don’t want to manage it on a day-to-day basis. It gives a legal structure for granting different forms of ownership interests.
Clients, workers, vendors, and lenders frequently see corporations as more professional and respectable than sole proprietorships or partnerships. Forming a corporation when a small business expands and develops partnerships with a range of third parties can be a strategy to improve the company’s profile and make it look more established.
Our business attorney can assist you in determining which sort of legal corporation is best for your scenario.
Contact our Business Attorney
When you incorporate as a business owner, you may be able to take advantage of tax planning alternatives. These include income splitting with family members, taking use of low corporate tax rates to delay tax, and even taking advantage of the capital gains exemption if your corporation is sold.
There are several crucial aspects to examine before deciding to incorporate to take advantage of these prospects. And, unlike other business people, you must evaluate the special restrictions that govern your profession while deciding whether or not incorporation is appropriate for you. Although there are several tax benefits to incorporating your business, as described above, it is critical that you consult with our business attorney before doing so. Contact us right away to set up a meeting with our corporate attorney.