As a small business owner or freelancer, you’ve probably heard that incorporating your business can lower your personal liability and maybe reduce your taxes too. But you most likely have some important questions including how to incorporate a small business and when to do it. You might even be wondering if you even need to do it at all.
Here are answers to some of the most commonly asked questions from small/solo businesses about incorporating in the U.S.
This question is talking about two separate things: registering the business (getting a business license) and then incorporating (or forming an LLC).
To answer the first part…Most likely. You’ll need to register your business with a local agency (city or county office) in order to legally conduct business there. You might need a business license, seller’s permit, or health/fire permit, depending on your type of business.
Start with your local government or treasury office to see what you need – or you can use an online tool like BusinessLicenses.com to check your licensing requirements.
For the second part of the question…You don’t need to incorporate or form an LLC to run your business, but it can be a good idea.
If you don’t create a formal business entity (like a corporation or LLC), then you will be operating as a sole proprietor (one person) or general partnership (two or more people). This is perfectly legal, but the downside is that there is no separation between you and the business and you’ll be personally on the hook for any issues that occur with your business (for example, the business is sued or can’t pay its bills).
After deciding that it’s a smart thing to create a formal business structure, the next question is which type of structure is best.
The LLC (Limited Liability Company) and Corporation are the two most common formal business structures in the U.S. Both of these entities help limit the business owner’s personal liability.
A corporation involves more formalities and paperwork than an LLC – this is why the LLC is often the preferred business type for small businesses that don’t want extra overhead.
Corporations issue shares to shareholders and these shares are easily transferrable from one person to another. For this reason, outside investors like to invest in corporations rather than LLCs.
It can be smart to set up a brief meeting with a tax advisor to discuss the various business structures and tax treatments and determine what’s best for your specific business and finances.
This question is very similar to the first question, and so is the answer. But when you’re dealing with multiple business owners, there’s another thing to consider. If your business is structured as a general partnership, you don’t get any liability protection for partnership debts and obligations.
Let’s say your business partner goes rogue, starts spending like crazy, and amasses a big business debt. You’ll be personally liable for paying this debt since there’s no separation between you and the business. For this reason, I think it’s absolutely imperative for multiple owners to protect themselves by forming a corporation or LLC.
While incorporating or forming an LLC can minimize your personal liability, it’s important to realize that a formal business structure doesn’t give you 100% “immunity.”
For example, having a corporation or LLC isn’t going to protect you if you commit a crime while running the business. And what’s probably more applicable to you as a freelancer- a business structure protects you personally from contractual lawsuits, but not tort lawsuits.
If you get in trouble because of your personal actions (i.e. you’re an accountant and make a mistake handling a client’s numbers), you can be personally liable because it was your own actions that caused the problem. This is the reason that doctors, drivers, and other professionals get a professional liability insurance policy.
It’s true; many large corporations incorporate in Delaware. This is because Delaware has the most developed and business-friendly laws in the U.S. In addition, a growing number of businesses are incorporating in Nevada because there are no state income taxes.
But if you’re a small business (less than five shareholders), it makes more sense to incorporate wherever you live or your business is physically based.
If you incorporate in a different state, you’re going to need to pay more fees and file more paperwork. For example, you may need to file an annual report and pay taxes in both the state where you’re located and the state where you’ve incorporated.
And as for state income tax? You’re going to have to follow the tax laws wherever you’re operating your business. For example, if you live and conduct business in California, you’ll need to pay California income tax- regardless of whether you’ve incorporated in Nevada.
The bottom line: If you’re small, keep it simple and incorporate wherever you are based.
Yes, definitely- a corporation can have one shareholder or many shareholders.
First of all, if you’re incorporating because you’re concerned about personal liability, then you should incorporate/form an LLC as soon as possible.
With that said, having the same business structure for the entire year will simplify your recordkeeping and tax filings. For that reason, some businesses choose to incorporate in the beginning of January.
If you use an online service to incorporate, you can check if they give you the option to get your paperwork in now, and then expedite the filing on the first business day in January.
You basically need to file incorporation paperwork with your state’s secretary of state office. Each state has its own specific paperwork and rules. You’ve got three options for handling this procedure:
Obviously, DIY is the cheapest, a lawyer is the most expensive, and an online service falls in between. Like with so many other services, picking the provider often boils down to what you have more of: time or money. And if you have a particularly complex share structure or are dealing with millions of dollars, you should have an attorney draw up your paperwork.
To be honest, this isn’t a common question, but I wish more people thought about it since it’s important.
Having a formal business structure means that you’ve got to keep up with certain formalities each year. The specifics vary by state.
Generally speaking, both LLCs and corporations will need to file an Annual Report with the state (along with an annual fee). A corporation will need to hold its annual shareholder meeting (even if you’re the only shareholder).
The paperwork is pretty straightforward, but ignoring it can cause the state to put your company into bad standing (and you can lose your personal liability protection). Check with your secretary of state’s office or an online service to find out what your specific requirements are.
If I’ve left anything out and you have other questions regarding incorporation, feel free to leave a comment below. I’m happy to answer.