Best Form of Incorporation: Everything You Need to Know
Larger companies that may want to one day offer their stocks publicly should consider forming a corporation.3 min read
2. Choosing a Structure Based on Taxes
3. Seeking Investments for Your Company
The best form of incorporation depends largely on the needs of your business. Larger companies that may want to one day offer their stocks publicly should consider forming a corporation. Smaller businesses that are looking for flexible management and liability protections may want to incorporate as a limited liability company (LLC). Learning about the different business entity types should help you decide the right option for your company.
Choosing the Right Business Structure
Choosing a business structure is one of the most important and difficult decisions that a business owner will face. The structure you choose will depend on the type of business you are running and what preferences you have for your structure. There are four basic structures you can choose:
- Limited liability company
- Sole proprietorship
If you're not sure which of these structures is right for your business, there are a few issues that you can consider to help with your choice:
- The liability protections offered by each structure.
- The cost of establishing each structure.
- Your potential tax burden.
- Whether your company will need investors.
Considering your personal liability is the most important part of selecting your business structure. If your company is in a field with a high level of risk, you should pick a structure that will shield you from being personally responsible for the debts of your business.
If you incorporate your business, meaning forming a corporation or LLC, you will receive strong liability protections. In most cases, creditors would not be able to pursue your personal assets to cover business debts. On the other hand, if you form a sole proprietorship or partnership, you can be personally liable for company debts.
While LLCs and corporations do provide strong liability protections, forming these businesses is costlier and time-consuming. If you choose one of these business structures, you will need to file formation documents with your state and pay incorporation and filing fees. The amount of the fee you owe depends on the state where you incorporate your business.
Electing company officers is another important part of starting an LLC or corporation. Your officers will be responsible for running your business, so you should be careful when appointing someone to this role. These types of business must also keep detailed business records, and corporations must observe formalities such as holding annual meetings.
Choosing a Structure Based on Taxes
Evaluating how your company will be taxed is another crucial part of choosing your business structure. Depending on the structure that you choose, your business profits will be taxed either once or twice. LLCs are pass-through entities, which means that company profits get distributed to the LLC's members and will be taxed on those members' personal returns. If you form an LLC, net business profits must be reported and taxed, even if the funds remained in the business.
Corporations are different in that owners only have to pay taxes on business profits if they are taken out of the business. Taxes can apply to income such as:
The drawback of forming a corporation is that business income is taxed directly at the corporate level, leading to double taxation if profits are allocated to business owners.
Seeking Investments for Your Company
If you want to seek outside investment for your company, then you should consider forming a corporation. For instance, with a corporation, you can fund your company by selling stocks, which isn't possible with other business structures. Selling stock can make it easier for you to entice investors, and it can also be a tool for retaining employees if you offer stocks as an incentive.
On the other hand, if you have no plans to take your company public and you don't need outside investment, then you may not want to form a corporation because of the cost involved. If you're only interested in forming a corporation because of the limited liability protections, you should establish an LLC instead. LLCs benefit from the same liability protections while offering more flexible management options.
With an LLC, the entity itself will be able to accomplish several tasks:
- Enter into contracts
- Hire employees
- Purchase assets
If you need help choosing the best form of incorporation, you can post your legal needs on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.