Every small business person considers whether or not to incorporate his business at some point. The form of a business isn't immutable; you can change the legal structure of your business as it grows. A common scenario is for small businesses to start out as sole proprietorships or partnerships and become incorporated at some later date when the business has grown.
If you're one of the people considering incorporating your business, here are the main advantages of incorporation:
1. Limited Liability
The main advantage to incorporating is the limited liability of the incorporated company. Unlike the sole proprietorship, where the business owner assumes all the liability of the company, when a business becomes incorporated, an individual shareholder's liability is limited to the amount he or she has invested in the company.
If you're a sole proprietor, your personal assets, such as your house and car can be seized to pay the debts of your business; as a shareholder in a corporation, you can't be held responsible for the debts of the corporation unless you've given a personal guarantee.
On the other hand, a corporation has the same rights as an individual; a corporation can own property, carry on business, incur liabilities and sue or be sued.
2. Corporations Carry On
Another advantage of incorporating is continuance. Unlike a sole proprietorship, a corporation has an unlimited life span; the corporation will continue to exist even if the shareholders die or leave the business, or if the ownership of the business changes.
3. Raising Money Is Easier
Corporations also have more ability to raise money, which may make it easier for your business to grow and develop. While corporations can borrow and incur debt like any sole proprietorship, they can also sell shares and raise equity capital, a big advantage because equity capital generally does not have to be repaid and incurs no interest. (Of course, by issuing shares, you are reducing your percentage of ownership in the company.)
4. Income Control
If you incorporate your small business, you can determine when you personally receive income, a real tax advantage. Instead of getting your income when it's received, being incorporated allows you to take your income at a time when you'll pay less in tax.
5. Potential Tax Deferral
Becoming incorporated gives you tax deferral potential. Because you can defer paying some tax until a later time, you may be able to realize tax savings if you are then in a lower tax bracket, or if the tax rates have fallen.
6. Income Splitting
Another tax advantage of incorporating is income splitting. Corporations pay dividends to their shareholders from the company's earnings. A shareholder does not have to be actively involved in the corporation's business activities to receive dividends. Your spouse and/or your children could be shareholders in your corporation, giving you the opportunity to redistribute income from family members in higher tax brackets to family members with lower incomes that are taxed at a lower rate.
7. The Small Business Tax Deduction
If you incorporate your business, it may qualify for the small business deduction. This annual tax credit is calculated at the rate of 16% on the first $200,000 of taxable income, which may be a much lower tax rate than that applied to your personal income.
8. Increased Business?
Having Ltd., Inc., Ltee., or Corp. as part of your company's name may increase your business, as people perceive corporations as being more stable than unincorporated businesses. If you're a contractor, you may also find that some companies will only do business with incorporated companies, because of liability issues.
Incorporating your small business sounds like a great idea, doesn't it? But there are also disadvantages to incorporating that you need to consider. These are outlined on the next page.