At some point, most small business owners will consider whether or not incorporating their business is the best strategy. Generally speaking, business forms are not absolute. It is possible to change the legal configuration of businesses throughout their existence. Most small businesses today begin as sole proprietorships or small partnerships and then become incorporated later when they begin to experience growth.
When considering incorporation for a business, it is very important that you fully understand both the advantages and the disadvantages, in order to make the decision that will ultimately be best for your individual business.
Advantages
Probably the main advantage of incorporating a business would be the limited liability for the company. With sole ownership or partnerships, the business owner automatically assumes all liabilities for the company. Once a business is incorporated, the individual liability of the shareholder is limited to the amount that they have invested into the company. Sole proprietors risk the seizure of their personal assets, such as homes and cars, to pay any debts that the business has incurred. When incorporated, business shareholders can not be held responsible for any debts that the corporation has incurred unless they are given a personal guarantee. However, corporations also have rights just as individuals do. Corporations can own property, incur liabilities and be sued or sue others just as proprietors can.
Another advantage of incorporating a business is the ability to raise money. Having this advantage can help you to grow and develop your business much easier. Keep in mind that corporations can borrow money and acquire debt just like sole proprietors. However they can also sell shares of the corporation to raise their equity capital quickly, which is a major advantage due to the fact that equity capital normally is not required to be repaid and does not incur interest as loans do. You should keep in mind however that if you are issuing shares of your corporation you are reducing your own percentage of ownership in the company, so this option should not be considered lightly.
In addition, corporations have unlimited life spans. The corporation will continue to exist even after shareholders die or leave the business. Continuance is also secure if ownership of the business should change such as if the business is sold. With sole proprietorships, once the owner dies or decides to leave the business for whatever reason, the business normally ends or may end up being sold to someone else who may change the way that the business is conducted.
Incorporation also allows for income control. When you incorporate your business, you have the power of determining when you will receive your income, which can be a great tax benefit. Typically, with a proprietorship income is taken when it is received. With incorporation, you have the ability to take your income at times when you will be required to pay fewer taxes. You also have the ability to defer taxes until such as time as you are in a lower tax bracket or until tax rates have fallen.
Income splitting is yet another advantage of incorporating your small business. Corporations disburse dividends to shareholders from the earnings of the company. Shareholders do not have to be involved in the daily business proceedings of the company directly to receive these dividends. Spouses and children can be shareholders in the corporation, which allows for the opportunity to redistribute the income from family members in a higher tax bracket to those with a lower income, which is taxed at a lower rate. Also, keep in mind that when you incorporate a business, the corporation itself may qualify for a small business tax deduction. This annual tax credit will be calculated at a 16 percent rate on the first $200,000 of taxable income. This may prove to be a significantly lower tax rate than what is applied to your personal income, giving you a much greater tax advantage.
You may also note an increase in business when you incorporate. Generally speaking, having the Ltd, Corp or Inc extensions at the end of your business name will give consumers the perception that your company is stable and more trustworthy. Many contractors find that companies prefer to do business with incorporated companies over sole proprietorships or partnerships simply due to liability issues.
So, those are the advantages of incorporating your small business. However, before you make your final decision on incorporation it is a good idea to weight the disadvantages against the benefits, just to ensure that you are doing what is right for your business.
Disadvantages
Probably the main disadvantage to incorporating your small business will be the increased amount of paperwork and the increased cost. These can be quite substantial when compared to a sole ownership or small partnership.
Keep in mind that when you incorporate your business you will be required to file two separate tax returns every year. One will be your personal income return and you will also need to file a tax return for your corporation. This may mean an increase in accounting fees. In addition, unlike sole business ownerships, losses from your corporation can not be deducted from your personal income.
There will be much more paperwork involved in managing and maintaining a corporation versus single ownership or a partnership. Corporations are required to keep a minute book, which contains bylaws and minutes from all corporate meetings. Other documents are also required to be kept up to date including a share register, transfer register and a register of directors.
Keep in mind also that there may be a tax disadvantage to incorporating your small business. Although there are many tax advantages, corporations are not permitted personal tax credits. Each and every dollar that a corporation earns will be taxed. As a single or sole owner, you may be able to claim many tax credits that you will not be entitled to should you incorporate.
You will also be faced with less tax flexibility. Corporations do not have the same elasticity as sole ownerships. As a sole owner, you can use operating losses to reduce your other sources of personal income during the year. Corporations however, can only use these losses to reduce the income of the corporation from other years.
The liability of incorporation may also not be a limited as it seems. While the main advantage of incorporating a small business is limited liability, this advantage may be weakened by personal guarantees or many credit agreements. If no one will give your corporation credit, then your limited liability is immaterial. If your corporation has insufficient assets to secure the loan that you need then credit institutions may require you to provide a personal guarantee. In this event, you will not be able to enjoy limited liability, as you will still end up being personally responsible if your corporation can not meet its repayment obligations. In this case, the limited liability has no bearing.
Finally, one disadvantage that stops many small businesses from incorporating is simply the fact that corporations are expensive to initiate. Corporations have a much more complex legal structure than sole ownerships and partnerships. Thus creating a corporation is much more complicated and expensive. The fees alone for incorporating your small business could prove to be in the hundreds to thousands of dollars for just the initial setup. You should also take into account that fees for increased accounting and other issues will cause the incorporation to be much more expensive than sole proprietorship.
Conclusion
So, should you consider small business incorporation? Weighing the pros and cons, or the advantages and disadvantages, is very important. Ultimately, the only way to decide what is best for your business is to take your business into consideration. You should discuss these aspects with both your accountant and your business attorney. Be sure to list all the advantages and why they will help your business, as well as the disadvantages and how detrimental to your company these may be. Incorporating a small business is not a decision that you should expect to make overnight. It takes a lot of research into your company and what is ultimately best for your business. Not all businesses will withstand incorporation. Some small businesses are simply not ready to be incorporated for any number of reasons. Be sure that you fully understand all the ramifications of incorporating before you make your final decision. Your attorney and/or accountant will be able to provide you with the big picture of how incorporation will affect your business and whether or not it will be a good step for you.
This is definitely not a decision to be made lightly. Understanding how corporations work, what is involved in setting them up and the overall running of business is important as well. Consider the financial, legal and personal aspects of incorporating. You should have a fairly good idea of what is expected before you choose incorporation. You must understand every detail of incorporating before you make the decision that will ultimately affect your business forever.
Biz Guides 
