Many business owners have the (well-founded) sense that incorporating is a good idea. However, they often lack a clear understanding about what the real benefits are. The following are four advantages of incorporating your business.
1. Asset Protection.
By incorporating, you are forming a new legal entity that is separate and distinct from you as an individual. Because you and the corporation are separate entities, you are, under most circumstances, not personally liable for its debts. So if the corporation incurs liability from its business operations, your personal assets (e.g., home, personal savings, etc.) will remain safe from the corporation’s creditors.
Contrast this with a situation where you run the business as a sole proprietor or partnership. In such cases, the owners are the business—they may, for example, sign contracts and take out loans in their own name for business purposes. But since there is no legal entity acting as a barrier between the owner and the business, they will be personally responsible for any liabilities arising from its operations.
2. Perpetual Existence.
If a business is run as a sole proprietorship and the proprietor passes away, the business will usually terminate as well. By comparison, a corporation generally has “perpetual existence,” meaning that it will survive even if its directors, officers and shareholders are no longer associated with it. This makes the corporation a much more resilient and stable vehicle for investment.
Rightly or wrongly, a corporation is usually viewed by third parties as having more credibility and legitimacy than a business run as a sole proprietorship. Those who would invest in or do business with the company may notice the corporate designation of “Inc.” or “Corporation” and assume a greater level of planning, sophistication, and permanence.
4. Tax Advantages.
Corporations are eligible for certain tax benefits and deductions that are unavailable to sole proprietorships and partnerships.
In addition, those who are self-employed may be able to reduce their Medicare and Social Security taxes (collectively, “self-employment taxes”) by forming an S-corporation. All income generated by a sole proprietorship is subject to self-employment taxes of 15.3%. In a partnership, these same taxes apply to each partner’s share of the partnership income. However, in an S-corporation, each shareholder may designate a portion of their share of the corporation’s income as distributions rather than as wages. This classification can result in substantial tax savings, because wages from services provided to an S-corporation are subject to self-employment taxes, but distributions are not. Thus, by classifying a portion of the income as distributions, an S-corporation shareholder can reduce his or her tax burden. One caveat: to avoid IRS scrutiny, shareholders must pay themselves a “reasonable” salary and refrain from designating an excessive amount of their S-corporation income as distributions.