Why is incorporation important to business? This process is important because it allows the business to become its own legal entity, separate from the owners.

Why Incorporation is Necessary

Incorporating is an important step in achieving business success. To start the process, you must prepare the required documents, including the articles of incorporation. The articles of incorporation and any other required documents will then be filed with the Secretary of State in the state in which the business will operate. The process of registering a business through the appropriate government agency is called incorporation. When a business incorporates, a new legal entity is created. The entity has the same powers a person would have under the laws.

Similar to an individual, a corporation can take legal action against another person or business and another business or person can take legal action against a corporation. Corporations can also:

  • Sign contracts
  • Sell and purchase property
  • Commit crimes
  • Be taxed

After incorporating, a business will exist either as a company or an association. Examples of associations include health and sports clubs and non-profit organizations. Under the law, the corporation has its own distinct identity that remains the same, regardless of any changes that may occur in the ownership or membership of the business. All legal business structures have their own advantages and disadvantages. Business owners must weigh the pros and cons to determine which structure is best, depend on the needs of the organization and the intentions to grow or expand.

When you own a small business, this comes with a substantial amount of risk. Incorporating that business can help limit your personal liability. Although incorporating does cost more and require more paperwork than forming a partnership or operating as a sole proprietorship, this action does offer tax and legal advantages. Incorporated businesses tend to be more professional than other business entities. The protections on personal assets are more extensive. Corporation owners can also take advantage of tax benefits and grow their businesses more effectively. When you incorporate, you are strategically and legally defining your business.

The two main types of corporations are:

  • S corporations (S corp)
  • C corporations (C corp)

You should compare the tax structures of each to determine which will be better for your business. One of the most notable protections granted to corporations and LLCs is the limited liability. If legal judgments or debts go against the business, the owners are only liable up to the amount they invested. Their separate, personal assets are not at risk.

Advantages to Incorporating your Business

Protecting your personal assets is one of the key advantages to incorporating your business. In a corporation, the shareholders will generally be held responsible up to their investment. External parties taking legal action or reclaiming business debts can't make claims on the personal assets of shareholders. By incorporating, you can do business without putting your personal property at risk, such as your savings account, personal vehicle, or residence.

When you own a partnership or sole proprietorship, your personal assets could be seized to pay for business debts as these business entities don't offer limited liability. When an LLC or corporation is well-managed and properly structured, the owners should only be liable for what they have invested in the business. A corporation does have to follow more formalities than an LLC, but these formalities can help protect the personal assets of the shareholders.

Another major advantage of incorporation is the tax benefit. Governments typically tax corporations at a fixed rate, while individual tax rates vary depending on the income level and other factors. When a business becomes more successful, it is financially beneficial and cost-effective to pay the corporate tax rate on the profits, rather than having to pay at the varying individual tax rate. Your business may also qualify for tax deductions on all types of costs associated with operating, which can reduce the overall liability for taxes.

Examples of corporation deductions include:

  • Retirement plan costs
  • Materials/production costs
  • Entertainment expenses
  • Business travel
  • Employee wages
  • Insurance premiums

LLCs and sole proprietorships are taxed at the same rate, although the LLC offers limited liability while the sole proprietorship does not. By default, an LLC is a pass-through tax entity, which means the business losses and profits pass through the business to the owners, who report the amounts on their personal tax returns. However, LLCs can elect for taxation as corporations.

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