Small business owners out there—we see you.
You’ve worked hard to grow your operations to what it is today. You’ve invested time, effort, and resources into building your business, achieving many milestones along the way.
And now you’re wondering: should I incorporate my small business?
Many companies in the US start as sole proprietorships or partnerships. Over time, though, many of them choose to incorporate so they can continue to scale and grow.
Incorporation is the right choice for some small businesses, but not all. Here we’ll look at what it is, when you should consider it, and how to go about it.
What Does It Mean to Incorporate Your Business?
Incorporation is defined as “the legal process used to form a corporate entity or company. A corporation is a legal entity that separates the firm’s assets and income from its owners and investors.”
Prior to incorporation, you and your business operate as a single legal entity. After incorporation, you’re separate.
Corporations are typically identified with terms such as “Inc.” or “Limited (Ltd.)” in their company name to identify it as a separate legal entity.
Benefits of Incorporating Your Business
There are many reasons to incorporate a business. The primary benefit is that incorporation legally separates you from your business, which protects your personal assets.
Your money is no longer personally tied to your business, so it is protected from any potential losses in your company (beyond your initial investment). It also means that business expenses, such as your office space rent, and other financial transactions are from separate bank accounts.
Here are other benefits to incorporating a business:
- Company’s liabilities aren’t tied to the owner.
- Ease of ownership transfer between different parties.
- More favorable tax rate than personal income.
- Option to raise capital through the sale of company shares.
- Protection from personal lawsuits.
- Brand protection.
- Perpetual existence (i.e., your business can outlast you).
These benefits can help a company scale and grow faster and with less risk than if it remains as a sole proprietorship or partnership. However, not all businesses need to be incorporated, so it’s important to consider what works for your context and goals.
When Should You Incorporate Your Business?
The first step is to understand your goals. What do you really want to accomplish with your small business?
Some small business owners are content to pay the bills with their business and operate as a solopreneur or with a small team.
Others have goals to become a global business with operations around the world.
And, of course, there are people who exist everywhere in the middle.
Your goals for your business will determine whether or not incorporation makes sense for your small business. With that in mind, here are a few situations in which incorporating makes sense:
- Removing personal liability: Until you incorporate, your personal finances are directly tied to your business. That means you have full responsibility and liability for the financial health of your company. Once you start to grow, you may want to separate these out and protect your personal assets. For example, if you’re sued or owe a lot of debt, your personal assets are protected once you’re incorporated—you don’t need to fund those debts yourself.
- Taxes: Corporations are taxed differently than individuals and there are generally more tax advantages for incorporated businesses. Again, as you start to grow, it may be more financially advantageous to incorporate. Consult with an accountant or tax professional to understand more about tax implications for your specific business, industry, and location.
- Raising capital and accessing loans: Incorporation makes it easier to both raise funds through investments and receive a business loan from the bank.
- Professional reputation: Incorporating your business means you will operate 100% under your company’s name. This can build a stronger professional reputation and increase brand image and recognition.
- Future-proofing your business: If you anticipate changing ownership or selling your company, this is much easier to do as an incorporation.
Take some time to consider these situations and if they make sense in your context. It may also be a wise choice to talk to an accountant or lawyer for professional advice regarding the state of your company where it is now.
When You Should Not Incorporate
Incorporation isn’t necessary for all small business owners.
Here are some times when it’s typically not necessary to incorporate:
- You work as a freelancer or consultant.
- Your primary goal is to cover your own salary with a business.
- You anticipate only having your business for a short time period.
- You don’t have a team of employees.
How to Incorporate Your Business?
If you decide to incorporate your business, you next need to know how to do so.
Note that this isn’t a comprehensive guide to incorporating a business. Because each business is unique, we recommend you speak to a professional or do your own research.
The Small Business Administration has extensive resources, guides, and tips for small business owners in the USA and is a great place to start.
Here are 5 steps to incorporate your business:
1. Choose Your Business Structure
There are multiple business structure options when you incorporate:
- LLC (limited liability company): This gives you the benefits of both a partnership and a corporation. Your personal and business assets are separated, but you’re still considered self-employed by the government.
- C corp (corporation): This is the option that provides the strongest protection to owners as corporations have completely independent finances from the owner or shareholders.
- S corp: Requiring special approval, S corps have some taxation advantages over a C Corp.
- B corp: This type of corporation is driven by mission and profit, and must demonstrate their positive contributions to the public.
- Nonprofit corporation: Nonprofits include charities, educational institutions, religious organizations, or scientific and literary work. They’re tax-exempt because of their public benefits.
2. Choose Your Location of Operation
The location in which you incorporate your business impacts the taxes you pay as well as licenses and permits to operate.
There are also some federal government incentives for small businesses that operate in underutilized business zones.
If you own a physical business such as a storefront or restaurant, you’ll incorporate your business in the city and state it resides in. This is the only option for you since you need to follow all local laws and regulations.
If you own a remote business or one that’s 100% online, you have more options.
You may choose to incorporate where you live or have a permanent residence, or you may choose a state that’s more favorable to businesses. For example, Shopify’s guide to incorporating an online business states that the three best states to incorporate are Delaware, Wyoming, and Nevada.
3. Register Your Business
To make your business a distinct legal identity, you need to register it with state and federal agencies. To do so, you need to:
- Get a registered agent: A registered agent receives official papers and legal documents on behalf of your company and is required for an LLC, corporation, or nonprofit.
- File with the state: Register your business with the Secretary of State’s Office by completing an “articles of incorporation” or “certificate of incorporation” document. If you’re here in Baltimore, this is the link to Maryland’s Secretary of state Business Express portal.
- File with the country: Registering federally requires you to only get a federal tax ID number (see below); S corps also need to fill out form 2553 with the IRS.
As you’re registering a business, you also want to check that your chosen business name is available.
Each state holds records of all the businesses that operate there, so you can perform a quick search in the database to ensure your name is available before submitting paperwork.
4. Get a Tax ID Number
A tax ID number, or an Employer Identification Number (EIN), is like a social security number for your business. It allows you to pay taxes and hire and pay employees. You can get a federal EIN with this IRS application.
5. Know Your Costs
There are some costs associated with incorporating your company:
- Incorporation fee: Approximately $100.00 to register with your Secretary of State.
- Incorporation service fee: If you use a service to file your paperwork, you can expect to pay between $200.00-$1,000.00.
- Registered agent fee: Approximately $100.00-$300.00 annually to use their services.
Additional fees may be related to permits specific to your business or professional services from a lawyer or accountant.
The paperwork to incorporate a business is fairly straightforward, but you can see there are many things to consider before you get there.
Spend some time considering what the best option for your business is and do some additional research to get all your questions answered. As mentioned, the SBA is a great resource, as are the Small Business Development Centers, a nationwide network of support.
Taking this next step in your small business journey is an exciting one! We can’t wait to see where you end up. And if you’re a small business owner or independent professional looking for the support and tools offered by a full-service office, book a tour of Co-Balt today.