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Many small business owners launch their companies as sole proprietorships in which they and their businesses are essentially one and the same. However, changing the format of a small business to a corporation or a Limited Liability Company (LLC) can offer a range of advantages for entrepreneurs. Most notable is that a corporation or LLC protects entrepreneurs' personal assets in case debts or legal judgments are claimed against the business.
The advantages of incorporating a small business include:
No. 1: Personal asset protection. Both corporations and LLCs allow owners to separate and protect their personal assets. In a properly structured and managed corporation or LLC, owners should have limited liability for business debts and obligations. Corporations generally have more corporate formalities than an LLC that must be observed to obtain personal asset protection.
No. 2: Additional credibility and name protection. Adding "Inc." or "LLC" after your business name can add instant legitimacy and authority. Consumers, vendors, and partners frequently prefer to do business with an incorporated company. In most states, other businesses may not form an entity or use a trade name that is the same as your corporate name. This benefits the business legally and helps in brand-building and marketing.
No. 3: Perpetual existence. Corporations and LLCs can continue to exist even if ownership or management changes. Sole proprietorships and partnerships just end if an owner dies or leaves the business.
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No. 4: Tax flexibility. An LLC is taxed at the same rate as a sole proprietorship while providing limited exposure to personal liability. Though profit and loss typically pass through an LLC and get reported on the personal income tax returns of owners, an LLC can also elect to be taxed as a corporation. When an entrepreneur sets up a corporation, he or she is taxed on both the individual and corporate levels. However, a corporation can avoid double taxation of corporate profits and dividends by electing Subchapter S tax status.
No. 5: Deductible expenses. Both corporations and LLCs may deduct normal business expenses, including salaries, before they allocate income to owners.
Should My Business Incorporate or Form an LLC?
I am often asked this question. It is important to consider the following:
1. Corporations and LLCs are both separate legal entities (business structures) that enjoy certain protections under the law and important benefits. Most people form a legal business structure to safeguard their personal assets.
2. Incorporating or forming an LLC allows you to conduct your business without worrying that you might lose your home, car, or personal savings because of a business liability.
The chart below can help you in your decision-making:
Deciding Which Business Structure is Right for You
Selecting the right type of company for your new business helps maximize your chances of financial and operational success. To get the most out of your small business, choose the right structure with an attorney or accountant. The Company Corporation does not provide tax or legal advice, but it can help you incorporate quickly and inexpensively.
This opinion column was written by E.J. Dealy, CEO of The Company Corporation, the small business unit at Corporation Service Company® (CSC®), which incorporates tens of thousands of new businesses annually and provides ongoing compliance services to 200,000 companies located throughout the U.S.