Recently I discussed the serious matter of liability in business and how even freelancers and small businesses should consider incorporating in order to separate their personal finances from their business.
For most new entrepreneurs, the process of incorporating (or forming an LLC) is an unfamiliar road to navigate. And let’s face it, when you’re burning the candle at both ends to meet your clients’ crazy deadlines or launch a website, legal paperwork isn’t necessarily high on your priority list.
Here’s a quick primer on incorporating in the U.S. to help you decide what’s best for your business:
Pick a business structure
Choosing your business’ legal structure is a critical decision as it can impact the taxes you pay, your ability to raise capital, as well as the amount of paperwork you’ll have to contend with. The three most popular business structures in the U.S. are the LLC (Limited Liability Company), S Corporation and C Corporation. Here are some basic definitions:
- LLC: Form an LLC if you want legal protection, but minimal formality — i.e. no exhaustive meeting minutes or addendum filings. It’s also the perfect structure for a start-up who will have foreign owners. An LLC’s main benefit, as the name suggests, is to limit the liability of the owners (separating your personal property from company property). An LLC does not file separate taxes; all company profits are passed through to the owners and reported on their personal tax returns.
- C Corporation: In the majority of cases, a C Corporation is overkill for the small business or freelancer. Operating as a C Corp requires a good deal of legal paperwork and formalities. In addition, a Corp is taxed separately and the company must file its own tax returns. This can lead to the problem of ‘double taxation’ where both the company and the company owners must file and pay taxes. However, a C Corporation should be used for those businesses that plan to reinvest their profits back into the company, seek venture capital funding, or go public.
- S Corporation: An S Corporation actually starts off as a C-Corp and then soon after incorporation, the owners submit paperwork to the IRS to be treated as a pass-through entity. This means that like the LLC, an S Corporation does not file its own taxes. An S Corporation is great for a small business owner who can qualify: The IRS places limits both on the number of owners and on who can be an owner in an S Corporation.
Pick your state of incorporation
Delaware and Nevada are both popular states for incorporation in the U.S. Delaware offers some of the most flexible, pro-business statutes in the country and Nevada offers low filing fees, as well as the lack of state corporate income, franchise, and personal income taxes. However, as a general rule of thumb, if your business will have fewer than 5 shareholders, it’s best to just incorporate in the state where you actually live or have a physical presence. Otherwise, all the added fees and paperwork created by ‘operating out of state’ just aren’t worth it.
How to incorporate or form an LLC
The process to incorporate or form an LLC is relatively easy these days. There are three common methods and each has its own set of pros and cons depending on your specific situation.
How do I incorporate or form an LLC?
There are three common methods for incorporating or forming an LLC. Each has its own unique advantages and disadvantages depending on your needs:
- Do-it-yourself: DIY is the lowest cost method, but you’ll need to do everything yourself. In short, you’ll need to submit the incorporation forms to your state’s secretary of state office. This is the best option is you’re more interested in saving money than time. You have to be able deal with lots of details and arbitrary rules.
- Online legal filing service: This next option is slightly more expensive than DIY. An online legal filing service will complete and file the documentation for you. Like any legal document, the articles of incorporation and application are full of tedious details (for example, some states have specific requirements about paper size and ink color!). A professional service can make sure that your application is done right and processed smoothly.
- Lawyer: This is the most expensive option, but may be necessary in certain situations. For example, if you have complex requirements for how your stock should be allocated or you are working with millions of dollars, then you should turn to expert advice.
When to incorporate
As for timing, since the main benefit of incorporation is liability protection, the sooner you incorporate or form an LLC, the better. There’s simply no reason to wait and potentially expose yourself to any more liability.
The act of incorporation or LLC formation won’t break the bank, particularly if you use an online legal filing service or file the forms yourself. Whatever method you choose, know that you’re taking an important step for your business and your finances.
About the author: Nellie Akalp is the CEO of CorpNet.com, an online incorporation filing service, where she helps entrepreneurs Incorporate, Form an LLC or set up Sole Proprietorships(DBAs) for their new businesses.