Should You Incorporate?
 By B.J. Addington

Nearly as important as your decision to go into business is your decision about what legal form your business should take.

Should you incorporate or would it be better to operate as a sole proprietor? Is a partnership preferable or perhaps a limited liability corporation? If a corporation, should it be a C or S? To know which option is best, you must know what the other alternatives offer by comparison.

For those new to business, the variety can be intimidating. But the benefits of each are fairly obvious, once you understand how they differ from each other.

Before making a final decision on your form of business, save yourself some headaches by consulting with a CPA and an attorney. In the meantime, here’s a quick checklist for you to weigh the relative merits of each type of business ownership.

Sole Proprietorship
Sole proprietorships are popular because they’re easy and inexpensive to set up and to operate. The owner has absolute control over all business decisions.

On the negative side, the owner may incur expenses and liabilities that exceed the total investment. The owner also is directly responsible for the business’ debts, which exposes personal finances to risk. You could not only lose your business, but you could also lose your house, your personal savings and any other assets.

Partnership
This is the most common form of business when there is more than one owner. The two types of partnerships are general and limited. A general partnership can be based on oral agreements, but it’s best to get legal advice. It’s usually less expensive to have an attorney draw up partnership agreements than it is to draft corporate documents.

A limited partnership is different from a general partnership in allowing for partners who invest, but do not run the business. The limited partner is liable only up the amount of his investment. A limited partnership must have one or more general partners, who manage the business and who, like sole proprietors, are personally liable for debts. General partnerships have no limited partners.

Whichever type of partnership you choose, it’s advisable to have a formal partnership agreement, or else you will find yourself at the mercy of the state’s laws regarding dissolutions and disputes.

The advantages of partnerships are less cost, less paperwork and fewer state registrations in forming and running the company. A partnership is not separately taxed. Profits pass through to the partners who pay income tax.

Corporation
For maximum personal protection, forming a corporation, also known as a C corporation, is the best choice. It’s also the most expensive and complicated to set up and run. Although it is potentially the most complex form for a business to take, you can incorporate without an attorney. But paying for legal advice is generally money well-spent, considering the intricacies of a complex legal system.

Corporation control is determined by stock ownership. The holder(s) of the majority of stock (50 percent plus one share) controls the corporation and the ability to make policy decisions. A board of directors, each of whom may or may not own stock, conduct company policy business at regular meetings and annual stockholder meetings. You must maintain minutes of all meetings. Annual fees and corporate taxes are paid to the state.

Although corporations shield the owners (stockholders) from personal liability, officers of a corporation can be liable to stockholders for improper actions, though their liability generally is limited to the amount of their stock ownership unless fraud is involved.

For small businesses, there can be tax advantages to incorporation. But owners are also effectively taxed twice – once when the corporation pays its income tax, then again when the owner pays income tax on his corporate income.

S Corporation
The advantage of an S corporation is that it also provides liability protection for stockholders, but does not pay taxes the same way as a C corporation. Instead, taxable income, losses, deductions and credits are passed through to stockholders, who pay at a lower rate than the corporation would.

Limited Liability Company
Most states now allow limited liability corporations (LLC). They are similar to and taxed in the way of partnerships. Like S and C corporations, an LLC also offers the benefit of limited liability for individual owners. LLCs, however, don’t provide some of the limits on the number and status of ownership that S corporations do.


(Posted July 2005)

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